In the short-term, average cost curves are U-shaped. The U-shape average cost curve implies that the average cost curve falls in the early stages and it then moves up beyond a certain point.
It can be on account of the following reasons:
(a) Basis of Average Fixed Cost and Average Variable Cost : Average cost is the aggregate of Average Fixed Cost and Average Variable Cost. With every increase in the output, the average fixed cost and average variable cost falls. But after a minimum value, average variable cost stops falling, but not the average cost. The point, where AC is minimum, is called the optimum point. Therefore, it is only due to the nature of AFC and AVC that AC first falls, reaches minimum and afterwards starts rising upward and hence assumes the U-shape.
(b) Basis of the Law of Variable Proportion : The U-shape of the short-run average cost curve can also be explained in terms of the law of variable proportion. This law states that when the quantity of a variable factor is changed, then the Total Production increases while determining the quantity of other components, but after some time, it starts decreasing. In this phase, the AC output of the firm is increasing because it is operating under the law of rising returns due to various internal economies. Thus, the ‘U’ size of short-run average cost reduction is due to non-proportional returns on the given scale of the plant.
