Question

Initially ATC declines. This is due to the ____________.

a. Diminishing Returns Effect

b. The Substitution Effect

c. The Spreading Effect

d. The Fixed Cost Effect

Answer 1

Option C is correct - Spreading effect

We know that there are both fixed and variable factors of production in the production process. And the fixed cost remains the same for all levels of production. Initially, when the firm is expanding its production level by increasing its quantity produced, the greater output is being produced with the same level of fixed costs. This decreases the cost per unit of production. When an increase in production level decreases the average fixed cost, average total cost also decreases. Therefore the ATC declines. This is called spreading effect (greater output is spread over the same amount of fixed input).