Which cost will always decrease as the production of the firm increases in the short-run?

Question

Accepted Answer

The correct option is 2:
The cost component that will always decrease as the production of a firm increases in the short-run is Average Fixed Cost (AFC). In the short run, Fixed Costs (like rent, insurance, or the cost of machinery) remain constant regardless of the level of output. The formula for AFC is Total Fixed Cost (TFC) divided by the Quantity of Output (Q), or AFC = TFC/Q. Since TFC is a fixed number, as the firm increases its production (Q increases), the constant fixed cost is spread over a larger and larger number of units. Mathematically, dividing a constant numerator (TFC) by an increasing denominator (Q) must result in a continuously falling value for AFC. This phenomenon is often referred to as 'spreading the overheads'. Because fixed costs are unavoidable in the short run, increasing output is the only way to lower the average fixed cost per unit.

The incorrect option is 1:
Average Variable Cost (AVC) is the variable cost per unit of output. The AVC curve is typically U-shaped in the short run due to the Law of Variable Proportions. It initially decreases, reaches a minimum point, and then starts increasing as diminishing returns set in. Therefore, it does not *always* decrease.

The incorrect option is 3:
This option suggests both AVC and AFC always decrease. While AFC always decreases, AVC follows a U-shaped pattern (decreasing then increasing). Since AVC eventually increases, this option is incorrect.

The incorrect option is 4:
Total Fixed Cost (TFC) is the sum of all costs that do not change with output. By definition of the short run, TFC remains constant regardless of whether production increases or decreases (as long as production is greater than zero). It is the total fixed cost, not the average, which is fixed.