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Why is the average cost curve u-shaped?  

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aayersrock | Student, Undergraduate | eNotes Newbie

Posted May 19, 2011 at 4:09 PM via web

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Why is the average cost curve u-shaped?

 

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted May 19, 2011 at 10:11 PM (Answer #1)

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The average cost curve is u-shaped (high costs when the number of units produced is low, decreasing costs as the number of units increases, high costs again as the number of units gets "too" high) because of two things.  The first is fixed costs and the second is the law of diminishing returns.

Most sorts of production have some fixed costs.  You can't have a bakery, for example, without having a building and equipment like ovens.  When you first start producing baked goods, the average costs are high because you are making only a few goods and the fixed cost of the ovens is high. (High costs/few goods = high average costs).

As you make more baked goods, the average costs drop because you are making more units of product in the same ovens.  (High costs/many goods = lower average costs)

Once you pass a certain point, the law of diminishing marginal returns sets in and your variable costs rise.  As the link below says,

There are bound to be some inputs which cannot be increased indefinitely, at least in the short run. When output is high, shortages of these restrict the efficiency with which such inputs as can be varied contribute to more output. Thus at high levels of output marginal costs tend to be high, leading to increasing average costs.

For these reasons the average cost curve is u-shaped.

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