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IAI Actuarial Core Principles · Business Economics · Production, costs, revenue and profit in price and output decisions

A Mumbai asset manager's short-run average total cost curve is U-shaped. Marginal cost cuts it from below at the minimum point. Which explanation of the rising section beyond that point is correct?

Beyond the minimum point, diminishing marginal returns push marginal cost above average total cost, and any marginal value above an average pulls that average up. Average fixed cost keeps falling, and scale economies are a long-run idea, so they do not explain the short-run rise.

  1. AAverage fixed cost begins to rise as output expands
  2. BDiminishing marginal returns raise marginal cost above average total cost, pulling the average upCorrect
  3. CEconomies of scale cease because all inputs are variable
  4. DFixed costs become variable once output is large
  5. Marginal cost falls below average cost, pulling the average up

Explanation

In the short run at least one input is fixed, so extra variable input yields diminishing marginal returns and rising marginal cost. Once MC exceeds ATC, the average must rise. Average fixed cost never rises with output, and an MC below average would pull the average down, not up. Scale effects belong to the long run.

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