Which of the following statements best explains why the average variable cost (AVC) curve is typically U-shaped in the short run?

• A. The AVC curve is U-shaped because fixed costs are spread over more units as output increases.
• B. Initially, increasing marginal returns to the variable input cause AVC to fall, but eventually diminishing marginal returns cause AVC to rise.
• C. The AVC curve is U-shaped due to economies and diseconomies of scale in the long run.
• D. The AVC curve is U-shaped because total cost always increases at a decreasing rate.

Answer: (B)

Verified step by step guidance

1. Understand that the Average Variable Cost (AVC) curve represents the variable cost per unit of output, which changes as production levels change in the short run.
2. Recall the concept of marginal returns: initially, when more units of a variable input (like labor) are added to fixed inputs (like capital), marginal returns increase, meaning each additional unit of input adds more to output than the previous one.
3. Recognize that during this phase of increasing marginal returns, the AVC decreases because the variable cost is spread more efficiently over a larger output.
4. After a certain point, diminishing marginal returns set in, meaning each additional unit of the variable input adds less to output than the previous one, causing the AVC to rise as producing additional units becomes less efficient.
5. Conclude that the AVC curve is U-shaped because it first falls due to increasing marginal returns and then rises due to diminishing marginal returns, reflecting changes in productivity of the variable input in the short run.