Why is the short-run cost (SAC) curve U-shaped? Why is the short-run cost (SAC) curve U-shaped?

Why is the short-run cost (SAC) curve U-shaped?

why-is-SAC-U-shaped
Figure: U Shaped SAC Curve

Why is SAC U Shaped?

The nature of the SAC curve is ‘U’ shaped. The traditional SAC curve is ‘U’ Shaped while the modern SAC curve is ‘⌴’ shaped. That is, the modern SAC curve is more flattened at its bottom. This means the SAC curve falls at the beginning and then reaches a minimum point to rise thereafter. In the case of the modern SAC curve, the minimum point stays stable for a longer period of time and then rises again while the traditional AC curve rises more quickly than the modern AC curve. Therefore, the traditional SAC curve is U-Shaped while the modern SAC curve is ‘⌴’ shaped. SAC curve is U-Shaped because of the following four major reasons:

 

a) Inclusion of AFC and AVC:

SAC includes both AFC and AVC. i.e;

why-is-SAC-U-Shaped-1

∴ SAC = AFC + AVC

 

When the output increases, AFC falls continuously throughout the increment in output up to a certain level. After reaching a minimum point, AFC starts to rise. Similar nature is shown by the AVC curve too which is due to the operation of increasing returns to scale during the production process. However, the rise in AVC is greater than the rate of fall in AFC due to the operation of the law of diminishing returns. Since SAC includes both AFC and AVC, the joint effect of both the costs causes SAC to rise after reaching a minimum point. So, the SAC curve is U-shaped.

 

b) Applicability of the law of variable proportions: 

SAC is U-Shaped also because of the operation of the law of variable proportion in short-run production. SAC curve falls at the beginning because the combination of a variable factor with a fixed factor causes production to increase at an increasing rate. When there are diminishing returns in production, Total Product (TP) decreases causing SAC to rise again. Hence, SAC becomes ‘U’ shaped.

 

c) Indivisibility of fixed factors:

SAC curve takes a ‘U’ shape because of the inseparability of fixed factors of production. During the short run, a firm cannot separate or divide the fixed factors of production which leads to the fall in AC. This is due to the operation of economies of scale. After a certain level of output, SAC rises again because of internal economies of scale. Hence, SAC becomes U-Shaped.

 

d) Economies and Diseconomies of scale:

At the beginning of the production process, there are certain internal and external dis-economies of scale which result in higher SAC. Gradually, the producer becomes aware as the production activities continue further. Certain economies of scale cause the cost to decline till it becomes minimum. This motivates the producer to increase the level of output. However, after a point, it becomes too large for the producer to handle the output. The reduced costs are not guaranteed due to internal and external dis-economies of scale which push the costs up. Hence, the SAC curve is ‘U’ shaped.

 

The ‘U’ shaped nature of SAC can also be clarified with the help of the following diagram:

why-is-SAC-U-shaped-2
Figure: U Shaped SAC Curve

 

The above diagram depicts the nature of the SAC curve which is ‘U’ shaped. During the initial production phase, the output produced was OQ1 which incurred C1 level of costs due to reasons such as managerial inefficiencies, perturbed input-output ratio, management issues, etc.

 

Gradually the cost declines to C2 and remains minimum at the OQ2 level of output because of optimum utilization of fixed factor, work division, specialization, and managerial abilities. However, a higher level of output OQ3 does not guarantee the same level of efficiencies and economies of scale as in OQ2. Therefore, the cost rises again to C3. When all these combinations of costs and outputs are joined together, we get a ‘U’ shaped SAC curve.

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