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The 'U' shape of the long-run average cost curve, unlike that of the short-run average cost curve, is explained by:
AThe law of variable proportions (fixed factor ratio)
BThe constancy of total fixed cost in the period
CFalling average fixed cost spread over more units
DReturns to scale: first increasing, then decreasing
Answer & Solution
Correct answer: D. Returns to scale: first increasing, then decreasing
1. In the long run all factors are variable, so there is no fixed factor ratio.
2. The U shape of LAC therefore arises from returns to scale: economies of scale first lower LAC, then diseconomies raise it.
3. So the explanation is increasing then decreasing returns to scale.
4. The variable-proportions law (A) explains the short-run U shape, and AFC effects (C) or fixed cost constancy (B) do not apply since no factor is fixed in the long run. Hence returns to scale.
_Source: ICAI BoS CA Foundation Paper 4 Business Economics, Ch 3 Unit II "Theory of Cost", p.10–11_
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