In the general textbook treatment, the firm’s short run average variab

In the general textbook treatment, the firm’s short run average variable and average total cost curves are U-shaped, while the average fixed cost curve is downward sloping over the entire range of output. Explain why.

What will be an ideal response?

ANSWER

The U-shaped AVC and ATC curves reflect the effects of diminishing marginal returns. When a firm incurs diminishing returns, marginal costs increase. So long as marginal cost is less than average total cost and average variable cost, they will decrease. However, when marginal costs rise above average total and average variable costs, the average costs must necessarily increase. In contrast, when calculating average fixed cost, total fixed cost is being spread over an increasingly larger amount of output. As this happens, the average cost per unit decreases.