A firm average cost decreases in the longrun because?

Analyze the question: The question asks why a firm's average cost falls in the long run. The key phrase is "long run," which means all factors of production are variable and the firm can change its scale of production.

Explain the concept:

• Short run: at least one factor is fixed. Costs change because of the law of diminishing returns, and average fixed cost (AFC) falls as output rises.
• Long run: all factors are variable. The long-run average cost (LRAC) curve is U-shaped because of returns to scale: • Increasing returns to scale (economies of scale): output rises by a larger proportion than inputs, so average cost falls. • Constant returns to scale: average cost stays the same. • Decreasing returns to scale (diseconomies of scale): average cost rises.

Check each option:

• A. Increasing returns to scale: This is correct. When all inputs are increased, output rises more than proportionately, so cost per unit falls. This is the long-run explanation.
• B. Diminishing average returns: This would make average cost rise, and it is a short-run concept.
• C. Decreasing marginal returns: This is also a short-run concept and pushes costs up, not down.
• D. Decreasing average fixed cost: AFC falls as output rises, but fixed costs exist only in the short run. In the long run, all costs are variable, so this is not the answer.

Exam tip: Match the time period to the concept:

• Short run goes with the law of diminishing returns and fixed costs.
• Long run goes with returns to scale and economies of scale.

When you see "long run" and "average cost falls," think economies of scale / increasing returns to scale.