Question

Why does vertical distance between AVC and SRATC gets smaller, as quantity produced increases for a typical company within the mainstram production model?

Answer 1

This is because , in the initial levels of production stage the firm gets increasing returns to scale that is the marginal cost falls with production and so does average variable cost. As average fixed cost is always decreasing with increasing levels of output , and average variable cost is decreasing initially , therefore , average total cost is decreasing initially. But with further increase in production , the firm gets decreasing returns to scale and with which marginal cost starts rising with which average variable cost starts rising. As average fixed cost is always falling , initially the weight of average fixed cost is more than average variable cost , therefore , average total cost falls to a certain level but then average variable cost has more weight and completely outweighs average fixed cost in determining the direction of average total cost. That is , average total cost after a certain level starts rising as the average variable cost and therefore as average fixed cost gets smaller and smaller with increased production , average variable cost gets closer and closer to average total cost therefore the gap between them smaller and smaller.