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The typical average cost curve in a competitive market is _____
The typical average cost curve in a competitive market is _____.
a. U-shape because the firm's fixed costs are first spread over greater quantities, but then increasingly greater quantities will create production capacity constraints
b. an upward-sloping straight line because fixed costs are constant, and variable costs are increasing with the level of output
c. U-shape because increasing quantities of output cause a decrease in fixed costs but an offsetting increase in variable costs
d. downward-sloping until fixed costs are eliminated and then it becomes a horizontal line
Expert Solution
The correct answer is a. U-shape because the firm's fixed costs are first spread over greater quantities, but then increasingly greater quantities will create production capacity constraints.
As output increases, the fixed costs start getting spread over a large number of units. This causes the average cost curve to go down. However, the average cost curve is not just made up of average fixed costs. It is also made of average variable cost. As production expands, average variable costs start to go up. After a minimum point in the average cost curve, the effect of the average variable cost outweighs the effect of the average fixed cost. With the average variable costs going up, we start to see the average cost going up as well.
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