ECON 1201 Lecture Notes - Lecture 18: Average Variable Cost, Marginal Cost, Diminishing Returns
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Increasing output has two opposing effects on average total cost: The spreading effect: the larger the output, the more output over which fixed cost is spread, leading to lower average fixed cost. The diminishing returns effect: the larger the output, the more variable input required to produce additional units, which leads to higher average variable cost. The minimum-cost output is the quantity of output at which average total cost is lowest- the bottom of the u-shaped average total cost curve. All inputs are variable in the long run. This means that in the long run, fixed cost (like factory size) may also vary. The firm will choose its fixed cost in the long run based on the level of output it expects to produce. There is a trade-off between higher fixed cost and lower variable cost for any given output, and vice versa.
