Question

Economies of scale can reward a company for growing. If the firm can achieve economies of scale, the average costs of a unit of production (of either a physical good or a “unit” of service) goes down as the company grows. What is the role of “fixed costs” in this?

Please use a graph to support your answer.

Answer 1

Fixed costs are costs which are fixed and are independent of the output produced. That is, these costs do not change when output increases.

Suppose fixed cost for a production process is $150

It means when Q = 1, FC will be 150

When Q = 100, FC will be 150

Since AFC = FC/Q

It means as output increases, average fixed cost decreases

This is an important contributor to falling AC, which makes way for economies of scale.

That is, as output increases, due to falling AFC, the total average cost of production also falls.

The graph for the same looks as below:

Thus, when as output increases, fall in AFC exceeds increase in variable costs, total AC falls, leading to economies of scale

Also, post that when increase in AVC exceeds fall in AFC, it leads to increase in AC, thereby leading to diseconomies of scale.