The thermal limit circuit can sink all of the current from the error amplifier output, and keep the regulator output voltage/current as low as needed to maintain the junction temperature at 160°C. As shown, the thermal limiter can "override" the voltage control loop when needed to prevent damage to the IC.
The LDO regulator is best suited for battery-powered applications, because the lower dropout voltage translates directly into cost savings by reducing the number of battery cells required to provide a regulated output voltage. If the input-output voltage differential is low (like 1V to 2V) the LDO is more efficient than a Standard regulator because of reduced power dissipation resulting from the load current multiplied times the input-output voltage differential.
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