The short run average cost is the sum total of average fixed cost and average variable cost. The average fixed cost declines as the total fixed cost is spread over a large volume of output. So the average total unit cost (or AC) falls sharply when output Increases.
As the firm is below normal capacity, Average variable cost will decline. The fall in average variable cost will down the average total unit cost of the beginning. After the normal point is reached average total unit cost will rise upward, when the firm produces more than normal capacity. Average variable cost rises quickly. The constant fall in the average fixed cost will not prove adequate to neutralize the rise in the average variable cost. Average cost will continue to rise in spite of fall in the average fixed cost.
Thus the behaviour of the average total unit cost curve will depend upon the behaviour of the average variable cost and average fixed cost curve. In the beginning both AVC and AFC curves fall, the ATC curve therefore falls in the beginning. When AVC curve begins to rise but AFC curve is falling steadily, ATC curve continues to fall. As during this time the fall in AFC curve weighs more than the rise in the AVC curve.
But with the rise in production, there is sharp rise in AVC which weighs more than the fall in AFC. Thus- ATC curve rises after a point. Therefore, Average total unit cost curve like AVC curve rises after a point. Thus, the average total cost curve (ATC) like the AVC curve first falls, reaches is minimum and then rises. The average total cost curve (ATC) thus, takes the shape of English alphabet ‘U’.