The spreading effect states that as output increases, what happens to average fixed cost?

As output increases, the average fixed cost decreases. This is primarily because average fixed cost (AFC) is calculated by dividing total fixed costs by the quantity of output produced. Since fixed costs do not change with the level of output—meaning they remain constant regardless of how much is produced—when you spread these fixed costs over a larger number of units, the average cost per unit decreases.

For instance, if a factory has fixed costs of $1,000, and produces 100 units, the average fixed cost is $10 per unit ($1,000/100). However, if the factory increases production to 200 units, the average fixed cost drops to $5 per unit ($1,000/200). This phenomenon illustrates the spreading effect, where increasing production leads to lower average fixed costs as the total fixed cost is distributed over more units of output.

This concept is essential in microeconomics and helps explain how businesses can achieve economies of scale, as larger production runs can lead to lower per-unit costs, thereby enhancing profitability.