Why average cost curve is u shaped

Figure 3. Other SRAC curves, not shown in the diagram, lie between the ones that are shown here. The long-run average cost LRAC curve shows the lowest cost for producing each quantity of output when fixed costs can vary, and so it is formed by the bottom edge of the family of SRAC curves. The long-run average cost curve shows the cost of producing each quantity in the long run, when the firm can choose its level of fixed costs and thus choose which short-run average costs it desires.

If the firm plans to produce in the long run at an output of Q 3 , it should make the set of investments that will lead it to locate on SRAC 3 , which allows producing q 3 at the lowest cost. At SRAC 2 the level of fixed costs is too low for producing Q 3 at lowest possible cost, and producing q 3 would require adding a very high level of variable costs and make the average cost very high.

At SRAC 4 , the level of fixed costs is too high for producing q 3 at lowest possible cost, and again average costs would be very high as a result. The shape of the long-run cost curve, in Figure 3, is fairly common for many industries.

The left-hand portion of the long-run average cost curve, where it is downward- sloping from output levels Q 1 to Q 2 to Q 3 , illustrates the case of economies of scale. In this portion of the long-run average cost curve, larger scale leads to lower average costs. We illustrated this pattern earlier in Figure 2.

In the middle portion of the long-run average cost curve, the flat portion of the curve around Q 3 , economies of scale have been exhausted. In this situation, allowing all inputs to expand does not much change the average cost of production. We call this constant returns to scale. In this LRAC curve range, the average cost of production does not change much as scale rises or falls.

Finally, the right-hand portion of the long-run average cost curve, running from output level Q4 to Q5, shows a situation where, as the level of output and the scale rises, average costs rise as well. Performance Performance. Performance cookies are used to understand and analyze the key performance indexes of the website which helps in delivering a better user experience for the visitors. Analytics Analytics. Analytical cookies are used to understand how visitors interact with the website.

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You could not be signed in, please check and try again. Sign in with your library card Please enter your library card number. Show Summary Details Overview U-shaped average cost curve. All rights reserved. The total variable cost TVC curve slopes up at an accelerating rate, reflecting the law of diminishing marginal returns. The total cost TC curve is found by adding total fixed and total variable costs. Its position reflects the amount of fixed costs, and its gradient reflects variable costs.

Average fixed costs are found by dividing total fixed costs by output. As fixed cost is divided by an increasing output, average fixed costs will continue to fall. The average variable cost AVC curve will at first slope down from left to right, then reach a minimum point, and rise again. Average total cost ATC is also called average cost or unit cost.

Average total costs are a key cost in the theory of the firm because they indicate how efficiently scarce resources are being used. Average variable costs are found by dividing total fixed variable costs by output. Marginal cost is the cost of producing one extra unit of output.

It can be found by calculating the change in total cost when output is increased by one unit.