Why is the short-run average total cost curve of a firm 'U' shaped?

Average total cost is calculated follows:

• average total cost = average fixed cost + average variable cost

Average fixed cost declines as more is produced, because the constant fixed cost is spread over a larger quantity of output. Average variable cost will increase with output because of diminishing marginal product, which implies increasing marginal cost.

When output is relatively low, diminishing marginal product is not as strong, therefore, the declining in average fixed cost is more dominant. As a result, average total cost falls with output. As more and more is produced, the increasing marginal cost becomes more dominant, and the rise in average variable cost outweighs the fall in average fixed cost. As a result, the average total cost increases with output. Hence, average total cost is U-shaped.