A Level Economics AQA Practice Exam

What is the effect of diseconomies of scale on a firm's operations?

1. Decrease in average costs

2. Increase in average costs

3. No effect on average costs

4. Increased sales revenue

The correct answer is: Increase in average costs

Diseconomies of scale occur when a firm increases its output, but the average costs begin to rise instead of decrease. This generally happens due to various factors, such as increased complexity in management, coordination challenges, and inefficiencies that emerge as the scale of production expands. For instance, as firms grow larger, they may face difficulties in communication, motivation issues among employees, and delays in decision-making, all of which can lead to higher costs per unit of production. When average costs increase, firms may experience reduced competitive advantages because their production becomes less efficient compared to smaller firms that can manage operations more effectively. This can lead to higher prices for consumers and potentially lower market share for the larger firm if they cannot offset these costs through pricing strategies. In summary, the correct answer reflects the concept that as firms experience diseconomies of scale, their average costs increase, thus impacting their overall operational efficiency and competitive standing in the market.