Question

The economic phenomenon responsible for the decrease in average costs of a firm in the beginning with the increase in its output is :

• A. Economies of scale
• B. Diseconomies of scale
• C. Law of diminishing marginal return
• D. Opportunity cost principle

Hint:

Remember the shape of the LRAC curve:
- Downward sloping section = Economies of Scale (average cost decreases).
- Minimum point = Constant Returns to Scale (optimal size).
- Upward sloping section = Diseconomies of Scale (average cost increases).

Answer 1

The Correct Option is A

Step 1: Understanding the Concept:
As a firm expands its scale of production and produces more output, its long-run average cost (LRAC) curve typically goes through different phases.
The initial phase is characterized by a downward-sloping average cost curve.

Step 2: Detailed Explanation:
The decline in average cost during the initial stages of output expansion is caused by economies of scale.
As output increases, the firm benefits from several cost-saving advantages:
1. Technical economies: Better utilization of large-scale machinery and equipment.
2. Managerial economies: Specialization of management tasks.
3. Commercial economies: Purchasing raw materials in bulk at discounted prices.
4. Financial economies: Securing loans at lower interest rates due to larger asset bases.
All these factors help spread fixed overhead costs over a larger volume of output, reducing the average cost per unit.
Conversely, diseconomies of scale refer to the phase where further expansion causes average costs to rise due to management inefficiencies.
The law of diminishing marginal returns is a short-run concept explaining why marginal product eventually decreases when variable inputs are added to a fixed factor.
The opportunity cost principle states that the cost of an alternative must be foregone to pursue a certain action, which does not directly explain initial cost reductions.
Thus, the correct phenomenon is economies of scale.

Step 3: Final Answer:
The correct option is (A).