Question

What is the relationship between increasing returns to scale and decreasing average cost?

Answer 1

Increasing returns to scale means that the firm is experiencing economies of scale in which if the firm hires one more unit of production, the output increases at an increasing rate.

When the firm is experiencing an increasing return to scale then, its average cost per unit will decrease with an increase in production.

This happens when a firm is able to efficiently utilize its factors of production and is using an optimum allocation of its variable factors to its fixed factors. Each additional unit of variable factor employed on a fixed factor will increase the output and lower the per unit cost of production and also when the firm increases its production and is able to procure raw materials at a lower cost.