modern theory of cost | l shape LMC and LAC | saucer shaped cost curve

modern theory of cost | l shape LMC and LAC | saucer shaped cost curve

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• Morden theory of cost has been provided by economists like Stigler, Andrews, Sargent, Florence Friedman etc.
• According to the traditional theory of costs, costs are of 'U-shape. But according to modern economists, in real life cost curves are L-shaped. These are also called empirical curves.
• The Modern theory suggests the existence of ‘built-in-reserve capacity ‘which imparts flexibility and enables the plant to produce larger output without adding to the costs.
The businessman wants to have some reserve capacity for various reasons.
i. To meet seasonal and cyclical fluctuations in demand.
ii. It gives the businessman greater flexibility for repairs of broken-down machinery without disturbing the smooth flow of the production process.
iii. It gives greater freedom to the entrepreneurs to expand output if demand increases.
Technology makes it necessary to build into the plant some reserve capacity.


Short-run cost curve
Like traditional theory, modern theory also studies four types of short-run cost curves Average fixed cost, Average variable cost, Average cost, and marginal cost.
1. Average Variable Cost: The short-run average variable cost curve in modern microeconomic theory is saucer-shaped, that is, it is broadly U-shaped but has a flat stretch over a range of output. This flat stretch represents the built-in reserve capacity of the plant.
2. Average Fixed Cost: Same As in the traditional theory of cost, the average fixed costs in modern microeconomics, are also plotted as a rectangular hyperbola.
3. Average Cost: The short-run Average costs consist of the Average fixed costs and Average variable costs. The AFC curve is a rectangular hyperbola and the AVC curve first falls and then becomes horizontal within the range of reserve capacity. Beyond that, it starts rising steeply.
Short-Run Average Cost Curve. According to modern economists, the short-run Average Cost Curve continuously
falling up to a given level of output represents reserved capacity output. After that, the average cost
curve rises upward.
4. Short-Run Marginal Cost Curve: In the initial stages, SMC, to modern economists falls and MC lies below AVC. From point A to B, marginal cost becomes horizontal and equal to AVC In this situation, production takes place under reserved capacity. After point B, MC rises above the AVC.