What is the Modern Theory of Short Run Cost Curves?

The traditional U-shape of the cost curves has been questioned by several economists. In 1939, George Stigler suggested that the short run average variable cost curve has a flat stretch over a range of output (Figure 5.12).

This is so because a number of firms build their plants in such a manner that a range of output can be produced by them at

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the same average variable cost. This range of output is referred to as the reserve capacity of the firm. The short-run average variable cost is, thus, U-shaped with a flat stretch at its bottom as shown in Figure 5.12. In the modern theory, the short-run average variable cost curve is ‘saucer-shaped’.

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Fig. 5.12: In the modern theory of costs, the average variable cost curve is saucer-shaped in the short run. The flat stretch at the bottom begins at output OQ1 and continues till output OQ2. The firm can produce output Q1Q2 at the same AVC, which is the lowest.

The AFC curve, in modern theory, remains the same as that in the traditional theory. The short run AC, therefore, looks like one in Figure 5.13.

The long run AC in modern theory is L-shaped as shown in Figure 5.14. This is so due to reductions in the production costs when a large volume of output is produced.

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The large scale production leads to heavy cost cuts because of discounts the firm is able to get for bulk purchases of raw materials and advanced technology, highly qualified workforce and managerial staff the firm is capable of engaging.