Association of Chartered Certified Accountants (ACCA) Certification Practice Test

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

1. Flat

2. U-shaped

3. Descending

4. Increasingly steep

The correct answer is: U-shaped

The short-run average cost curve typically takes a U-shaped form due to the relationship between production levels and per-unit costs. Initially, as production increases, a firm can benefit from economies of scale, which leads to lower average costs. This downward slope reflects efficient utilization of resources and spreading fixed costs over a larger number of units. However, after reaching a certain level of production, the firm begins to experience diseconomies of scale, where average costs start to increase as output continues to expand. This can be attributed to factors such as increased complexity in management, overutilization of resources, and potential inefficiencies that develop from operating beyond optimal levels. Thus, the U-shape of the short-run average cost curve illustrates how average costs decrease initially before increasing, capturing the dynamics of production efficiency and inefficiencies as output changes.