A Level Economics AQA Practice Exam

What impact does increasing output have on average cost in the presence of economies of scale?

1. Average costs rise significantly

2. Average costs remain unchanged

3. Average costs decrease

4. Average costs can increase or decrease depending on the industry

The correct answer is: Average costs decrease

Increasing output in the presence of economies of scale leads to a decrease in average costs. Economies of scale refer to the cost advantages that a business obtains due to the scale of operation, with the average cost per unit of output generally decreasing as production increases. As firms produce more, they can spread their fixed costs (like rent and salaries) over a larger number of units, thus reducing the average fixed cost per unit. Additionally, firms might negotiate better terms for bulk purchases of materials or invest in more efficient technology that lowers variable costs. This operational efficiency results in lower average costs as output grows, which is a fundamental concept in economics concerning production and cost management. The incorrect options suggest outcomes that do not align with the principles of economies of scale. An increase in average costs or unchanged average costs contradicts the idea that more efficient production processes and bulk efficiencies drive costs down. Furthermore, positing that average costs could vary depending on the industry overlooks the consistent nature of how economies of scale function across industries, even though the degree to which they apply can vary.