Question

Given below are two statements about the shape of average cost curves:
Statement (I) : Short-run average cost curves are saucer-shaped
Statement (II) : Long-run average cost curves are U-shaped
In light of the Traditional Theory of Costs, choose the most appropriate answer from the options given below:

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

Hint:

In traditional economic theory, both SRAC and LRAC curves are U-shaped.
- SRAC is U-shaped due to the Law of Variable Proportions.
- LRAC is U-shaped due to economies and diseconomies of scale.
Saucer-shaped curves only appear in Modern Cost Theory.

Answer 1

The Correct Option is D

Step 1: Understanding the Concept:
Cost theory analysis classifies costs into short-run and long-run scenarios.
Traditional economic theory defines specific geometric shapes for Average Cost (AC) curves based on productivity laws.

Step 2: Detailed Explanation:
Statement (I) states that short-run average cost (SRAC) curves are saucer-shaped.
This statement is false under the traditional theory of costs.
According to traditional cost theory, the SRAC curve is distinctly U-shaped.
This U-shape is explained by the Law of Variable Proportions.
As variable inputs are added to a fixed factor:
1. Initially, average costs fall due to increasing marginal returns.
2. The curve reaches a minimum point.
3. Finally, average costs rise due to diminishing marginal returns.
Saucer-shaped curves (which feature a flat bottom) are associated with the modern theory of costs, where managers maintain excess capacity to keep unit costs constant over a range of outputs.
Statement (II) states that long-run average cost (LRAC) curves are U-shaped.
This statement is true under traditional theory.
The LRAC curve, also known as the envelope curve, wraps around multiple SRAC curves.
It is U-shaped due to the operation of economies of scale (which lower average costs as scale increases) followed by diseconomies of scale (which increase average costs as the firm grows too large).
Therefore, Statement (I) is false but Statement (II) is true.

Step 3: Final Answer:
The correct option is (D).