We know that, AC = AFC + AVC. In the beginning when output increases both AFC and AVC falls, because of operation of increasing returns or diminishing costs, so that AC falls till it reaches the minimum point. After this, any increase in output leads to increase in AVC because of operation of law of diminishing return or increasing cost.

Although AFC falls throughout, the rise of AVC is more than fall of AFC, so that their combined effect causes AC to rise. Hence, the shape of SAC becomes ‘U’ shaped.

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(b) On the basis of law of variable proportion:

Due to operation of law of variable proportion the SAC becomes ‘U’ shaped. When there is increasing return in production SAC falls and when there is diminishing return in production SAC rises. So, SAC becomes ‘U’ shaped in short-run.

(c) On the basis of Indivisibility of Fixed Factors:

When in the short-run a firm increases its production due to indivisibility of fixed factors, it gets various internal economies which cause SAC to fall. After a certain point SAC rises when there is operation of internal diseconomies. Hence, SAC becomes ‘U’ shaped.

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