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Why Average Cost Curve is "U" Shaped?

(With Diagram)

:

The following artile will guide you to !now why ost urve is U# shaped$

The addition of fixed and Variable Cost gives us total costs, which when divided by the output

give us Average Costs in the short period.

The nature of short period Average Cost Curve is ‘U shaped. To begin with, the Average Costs

are high at low levels of output because both the Average !ixed Costs and Average VariableCosts are "ore.

#ut, as the level of output increases, the Average Costs fall "ore sharply due to the co"binedeffect of the declining average fixed and Average Variable Costs.

This results fro" the use of indivisible factors and the reaping of internal econo"ies of labour,

technical, "anagerial, "ar$eting etc. The Average Cost will continue to fall till they reach the

"ini"u" point which is the opti"u" point level of output. %nce the opti"u" level of output isreached, Average Costs starts rising as "ore are produced beyond this level.

The rise in Average Variable Cost is "ore than off set by the s"all fall in Average !ixed Costsand hence the Average Costs rises &uic$ly. This is due to the change of econo"ies into dis'

econo"ies. This gives the short'run as well as long'run Average Cost Curve of the fir" ()shaped.

The nature ‘U shaped short'run Average Cost

curve can be attributed to the law of variable proportions. This law tells that when the &uantity of one variable factor is changed while $eeping the &uantities of other factors fixed, the total output

increases with an increasing rate and then declines with "ore than proportionate.

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Thus, the Average Costs of the fir"s continue to fall as output increases because it operates

under the increasing returns due to various internal econo"ies. *ue to the operation of the law of 

increasing returns the fir" is able to wor$ with the "achines to their opti"u" capacity and as aconse&uence the Average Cost is "ini"u".

(f the fir" tries to raise output after that point by increasing the &uantities of variable factors thefixed factors li$e "achines would be wor$ed beyond their capacity. This would lead to

disecono"ies of production and di"inishing returns. The Average Costs will start rising rapidly.+ence, due to the operation of aw of Variable proportions the short'run as well as long'run

Average Cost Curve is T- shaped.

The average cost curve is u'shaped high costs when the nu"ber of units produced is low,

decreasing costs as the nu"ber of units increases, high costs again as the nu"ber of units gets/too/ high0 because of two things. The first is fixed costs and the second is the law of

di"inishing returns.

1ost sorts of production have so"e fixed costs. 2ou can3t have a ba$ery, for exa"ple, withouthaving a building and e&uip"ent li$e ovens. 4hen you first start producing ba$ed goods, the

average costs are high because you are "a$ing only a few goods and the fi%ed cost of the ovens

is high. +igh costs5few goods 6 high average costs0.

As you "a$e "ore ba$ed goods, the average costs drop because you are "a$ing "ore units of product in the sa"e ovens. +igh costs5"any goods 6 lower average costs0

%nce you pass a certain point, the law of di"inishing "arginal returns sets in and your varia&le 

costs rise. As the lin$ below says,

There are bound to be so"e inputs which cannot be increased indefinitely, at least in the shortrun. 4hen output is high, shortages of these restrict the efficiency with which such inputs as can be varied contribute to "ore output. Thus at high levels of output "arginal costs tend to be high,

leading to increasing average costs.

!or these reasons the average cost curve is u'shaped.