A Level Economics AQA Practice Exam

What is the main reason for a U-shaped long run average cost curve?

1. Increased labor costs

2. Internal economies and diseconomies of scale

3. Increased raw material costs

4. The fixed cost of machinery

The correct answer is: Internal economies and diseconomies of scale

The correct answer emphasizes the concept of internal economies and diseconomies of scale, which are crucial in understanding the shape of the long-run average cost (LRAC) curve. A U-shaped LRAC curve illustrates how, as a firm increases its output, average costs initially decrease due to economies of scale and then eventually increase due to diseconomies of scale. In the early phases of production, firms can spread fixed costs, such as salaries and overhead, over a larger number of units. Operational efficiencies, bulk purchasing of inputs, and specialization of labor contribute to reduced per-unit costs. This condition leads to the downward-sloping section of the U-shaped curve. However, as production continues to increase, firms may encounter diseconomies of scale. These can arise from factors such as management challenges, increased complexity in communication and coordination, or overcrowding in production facilities. In this later phase, average costs begin to rise, creating the upward slope of the U-shape. Thus, the U-shape of the long-run average cost curve effectively reflects the interplay between these economies and diseconomies of scale as output changes.