Question

Among the following statements, what is/are true about the modern theory of costs?
Statement (I): Short-run average cost curves are saucer-shaped
Statement (II): Long-run average cost curves are U-shaped
In light of the above statements, choose the correct answer from the options given below.

• A. Both Statement (I) and Statement (II) are true.
• B. Statement (I) is false but Statement (II) is true.
• C. Statement (I) is true but Statement (II) is false.
• D. Both Statement (I) and Statement (II) are false.

Hint:

Under the Modern Theory of Costs:
Short-Run AC \(\rightarrow\) Saucer-shaped (due to reserve capacity).
Long-Run AC \(\rightarrow\) L-shaped (due to continuous learning and technical progress).

Answer 1

The Correct Option is C

Step 1: Understanding the Concept:
This question tests the differences between the traditional theory of costs and the modern theory of costs in microeconomics.

Step 3: Detailed Explanation:
Let us analyze the cost curves under both theories:
- Traditional Theory of Costs:
The short-run average cost (SAC) curve is strictly U-shaped due to the operation of the law of variable proportions.
The long-run average cost (LAC) curve is also U-shaped, primarily due to economies and diseconomies of scale.
- Modern Theory of Costs:
In the modern theory, economists (such as Andrews, Dean, and Stigler) suggested that empirical evidence does not support strictly U-shaped curves.
- Short-Run Cost Curves: The modern theory states that the Short-run Average Cost (SAC) curve is saucer-shaped.
It has a flat bottom over a significant range of output.
This flat stretch represents the firm's "reserve capacity," allowing it to expand production without experiencing immediate rising average costs.
Thus, Statement (I) is true.
- Long-Run Cost Curves: The modern theory suggests that the Long-run Average Cost (LAC) curve is L-shaped rather than U-shaped.
As output expands, production costs continuously decrease due to technical progress and organizational economies.
Even if economies of scale are fully realized, costs remain constant (flat) rather than rising, because managerial diseconomies can be avoided through decentralized management.
Thus, Statement (II) is false because the modern theory rejects the U-shaped long-run average cost curve.

Step 4: Final Answer:
Statement (I) is true, but Statement (II) is false.
Therefore, the correct choice is Option (C).