# average variable cost - Why U-shaped? (real life example plz)

The schweser textbook says that AVC is u-shaped, that it goes down then starts sloping upwards as total output increases.

Why wouldn’t it keep sloping downwards infinetly or be flat? The assumption is that with technology, economies of scale, that your variables would keep producing more goods?

Let’s take a car factory for example. Let’s assume the Fixed Costs are the rental costs of the industrial plant. Let’s assume that the variable costs are

1. Electricty (the more cars you try to build, the higher your utility bill is going to be)

2. Labor (more workers => more cars produced)

What are they trying to say? That in theory you will have so many employees that they wont all fit in the factory and you cant produce additional cars?

Tell me if I’m off-base. The book just lists a chart and states an economic law without really explaining it in practical terms.

In the short run, some factors of production are fixed. This is the reason why the SRATC is upward sloping after a certain point. For example, if you increase labour but you only have one plant, increasing labour to increase the quantity produced will lead to inefficiency after a certain point (initially, increasing labour to, say L1, will allow worker specialization so there will be reduced costs but the workers get in each others way after a certain point, say L2).

In the long run, all factors of production are variable. So you can open up more plants. If you have two plants, at L2, labour will still be able to specialize so you will get more efficiency. This is why the LRATC is downward sloping.

However, even in the long run, after a certain point, opening up many plants may become too costly. It will be harder to organize and co-ordinate the factors of production (labour in this example) so overall this will lead to inefficiency (the operations become too big to manage properly). This is why the LRATC is upward sloping after a certain point.

Essentially, when the LRATC is downward sloping you are getting increasing returns to scale, which means that for a marginal increase in the factors of production, you are getting a higher percentage output. When the LRATC is upward sloping you are getting decreasing returns to scale: for a marginal increase in factors of production, you are getting a correspondingly lower percentage increase in output.