Association of Chartered Certified Accountants (ACCA) Certification Practice Test

In the short run, the firm's supply curve is represented by which part of the cost curve?

1. The section below the average fixed cost (AFC) curve

2. The part of the marginal cost (MC) curve above the average variable cost (AVC) curve

3. The upward slope of the total cost (TC) curve

4. The entire average total cost (ATC) curve

The correct answer is: The part of the marginal cost (MC) curve above the average variable cost (AVC) curve

The firm's supply curve in the short run is represented by the part of the marginal cost (MC) curve that lies above the average variable cost (AVC) curve. This relationship emerges from the fundamental principles of cost and supply in the context of perfect competition. In the short run, firms operate under certain constraints, notably that their fixed costs cannot be adjusted. Therefore, they focus on variable costs, which affect their decision-making on production levels. The average variable cost (AVC) curve indicates the lowest price at which a firm can cover its variable costs. If the market price is above this curve, the firm can profitably produce and supply additional units of output since it contributes to covering fixed costs as well. When the price is below the AVC, the firm would not be able to cover its variable costs and would be better off shutting down in the short run. Thus, the upward-sloping portion of the marginal cost curve represents the prices at which firms are willing to supply additional units of output. This makes sense in terms of cost structure: as output increases, the marginal cost rises due to diminishing returns, and firms will only supply additional units if they can cover the marginal cost, which is linked to the prevailing market price. Understanding this