Why is short-run average cost curve(SAC) ‘U’ shaped ?/ Reasons for ‘U’ shaped SAC Curve
Basis of AFC:
AC includes AFC and AFC falls continuously with the increase in the output. Once, it has reached the minimum point, it starts rising. Similarly, AC also includes AVC which falls at the beginning and after some point, it starts rising. Therefore the SAC curve is ‘U’ shaped.
Basis of the law of variable proportion:
The ‘U’ shaped of AVC curve is due to the applicability of the law of variable proportion on production in the short run. This law states that when the variable factor is combined with a fixed factor, the production increases at an increasing rate, causing AC to fall. After some point, because of inefficiency and dis-economizing of the resources, AC starts to incline again. Therefore the SAC curve is ‘U’ shaped.
Indivisibility of factors:
SAC curve is ‘U’ shaped due to the indivisibility of factors of production. In the short run, as a firm increases the output, it enjoys certain internal economies due to the indivisibility of some fixed factors of production which results to fall in SAC. Later on, due to some internal and external factors, the production efficiency goes down and the cost rises. Therefore, SAC is ‘U’ shaped.
In the above diagram we can see that at the beginning phase of production, the output produced was Q1. It incurred cost ‘A’. Because of some efficiencies and managerial abilities, the cost has been reduced to ‘B’ and ‘C’ producing Q2 and Q3 level of output.
When more factors of production are employed to produce Q4 and Q5 level of output, the cost rises up again due to diseconomies of scale, managerial inefficiency, lack of labor division and other causes. When the combination of different level of cost and output is connected, then we get a ‘U’ shaped curve which is known as the SAC curve.