Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What is the general shape of the short-run average cost curve?

1. It is a straight line

2. It is a U shape

3. It is an inverted U shape

4. It is a diagonal line

The correct answer is: It is a U shape

The short-run average cost curve is typically U-shaped due to the relationship between average costs and production output at varying levels of efficiency. In the initial stages of production, as output increases, average costs tend to decrease. This decline occurs because fixed costs are spread over a larger number of units, leading to economies of scale. However, after reaching a certain level of production, the average costs begin to rise again. This increase is attributed to the law of diminishing returns, where adding more of a variable input to a fixed input yields progressively smaller increases in output. As a result, eventually, the additional costs associated with production begin to outweigh the benefits of spreading fixed costs, leading to higher average costs. Thus, the U-shape of the short-run average cost curve effectively illustrates the initial cost benefits of increased production followed by the inefficiencies that arise when output exceeds optimal capacity. This highlights the dynamic nature of production costs and their relationship with output levels, which is essential for making informed decisions in cost management and pricing strategy.