Final answer:
The 'bowl' shape of the average cost curve is explained by the initial decrease in costs due to spreading fixed costs over more units and economies of scale, followed by an increase due to diminishing returns. Marginal cost follows this shape as it impacts the average cost as production expands.
Step-by-step explanation:
One of the foundational concepts in microeconomics and business is understanding how costs behave in the short and long run. Two reasons that the average cost (AC) curve tends to have a "bowl" shape, or a U-shape, in the short run are economies of scale and diminishing returns. Initially, as production increases, fixed costs are spread over more units, leading to a decrease in average costs. Concurrently, firms may benefit from increased productivity and efficiency, known as economies of scale. However, after reaching a certain point, diminishing returns set in, and additional units of production cause average costs to rise due to factors such as increased complexity, overuse of fixed inputs, or the higher cost of additional resources. This results in the U-shaped average cost curve that decreases initially but eventually increases as output expands.
In the context of marginal cost (MC), it follows a similar trajectory because it represents the change in total cost from producing one additional unit. When MC is below AC, the average cost per unit falls; when MC is above AC, the average cost per unit rises. Initially, marginal costs decrease as the firm becomes more efficient, but eventually, they start to rise due to the law of diminishing marginal returns, where the additional cost of producing one more unit rises.
It's important to differentiate these short-run curves from the long-run average cost (LRAC) curve, which tends to be continuously downward-sloping in economies of scale. It represents a time period where all inputs can be varied, and no costs are fixed, allowing firms to achieve lower costs per unit as they increase production indefinitely. Conversely, the short-run curves assume the presence of fixed costs, with only variable costs changing.
The U-shaped average cost curve has significant implications for the number of firms that can compete in an industry and their respective sizes. With economies of scale, firms can produce at a lower cost for larger outputs, but only up to a point where they hit the minimum efficient scale. Beyond this point, costs start to increase. Therefore, industries with a significant range of economies of scale can support a variety of firm sizes, while industries with steeply rising long-run average cost curves past the point of minimum efficiency will tend to be dominated by a few large producers.