A Level Economics AQA Practice Exam

What generally happens to a firm's total long-run average cost as it increases production?

1. It continuously decreases

2. It increases at all production levels

3. It may decrease, level off, or rise depending on scale

4. It stabilizes at the initial production level

The correct answer is: It may decrease, level off, or rise depending on scale

As a firm increases production, its total long-run average cost can exhibit different behaviors based on the principles of economies of scale and diseconomies of scale. Initially, as production increases, a firm may benefit from economies of scale, where the average cost per unit decreases because fixed costs are spread over a larger output, and operational efficiencies are realized. However, after a certain point, the firm may experience constant returns to scale, where increasing production does not significantly change the average cost, and eventually encounter diseconomies of scale. These occur when increasing production leads to higher average costs due to factors such as management inefficiencies, over-utilization of resources, or logistical challenges. Therefore, it is accurate to say that the long-run average cost may decrease initially, stabilize at a certain level, or rise based on the scale of production. This variability illustrates the dynamics of production and cost associated with scaling operations, confirming that option C is the most accurate characterization.