Average total cost per unit is at a minimum in Figure 5.6 when the firm produce Q3.
This is achieved by combining an optimal combination of variable factors with our fixed
factor or factors. This optimal level of output is often referred to as full or optimum
capacity, i.e. the firm is producing at capacity. The firm can produce beyond capacity,
yet in doing so uses a less than optimal combination of fixed and variable factors. The
cost of moving beyond optimal output can be seen in terms of higher average costs of
production. Similarly, producing less than Q3 also proves less than fully efficient. The
firm is now said to be producing with reserve capacity.
Firms may nevertheless plan to produce with a degree of reserve capacity to cater for
variability in demand. Thus, if a lower division football club was planning a new stadium,
it would be likely to specify a seating capacity in excess of current average
attendance figures to cater for increased demand, particularly if it anticipated gaining
promotion to a higher division. Manufacturers may similarly currently produce with
spare capacity in anticipation of higher future levels of demand brought about by
improving market conditions. Alternatively, the firm could cater for changing demand
by stock inventory policy: building up or running down stock. Such a strategy can, however,
be less efficient than the ability to adjust output.
Although possessing a degree of spare capacity may appear attractive, our analysis, as
demonstrated in Figure 5.6, indicates that the cost of doing so is higher average costs of
production than if producing at capacity. However, the basic U-shaped cost curves of
traditional theory have consistently been questioned on empirical grounds as firms are
often observed to be able to vary output over a given range of output at constant
marginal cost, implying the short-run AVC curve to be ‘saucer-shaped’ over that range.
This is illustrated in Figure 5.7.