Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What shape does a firm's short run average cost (AC) curve typically take?

1. Flat

2. Linear

3. U-shaped

4. Exponential

The correct answer is: U-shaped

The short-run average cost (AC) curve typically takes a U-shaped form due to the relationship between costs and output levels in the short run. Initially, as production increases, the average cost per unit tends to decrease. This is attributed to economies of scale, where fixed costs are spread over a larger number of units, thus reducing the average total cost. However, after reaching a certain level of production, the average costs begin to rise again as diminishing returns set in. This means that while the firm is increasing output, it may experience lower costs per unit; however, after a certain point, producing additional units requires more resources that may not be as efficiently utilized, leading to increasing average costs. The U-shaped AC curve reflects this initial decrease followed by an increase in average costs, making it a critical tool for firms in their short-run decision-making processes regarding production levels. In contrast, a flat shape would suggest constant average costs regardless of output, which does not account for the impact of diminished returns. A linear shape would imply a steady change in costs, not reflecting the economies of scale and eventually rising costs. An exponential shape suggests extreme variability with increasing output, which is not typical in standard cost functions. Thus, the U-shaped curve effectively