In the long run, the average cost of a firm falls as long as increasi…

In the long run, the average cost of a firm falls as long as increasing returns to scale (IRS) operate. Why?

Answer & explanation

Correct answer: option 2

The correct answer is Option (2) → To raise output by a certain proportion, inputs, and so costs, need to rise by a smaller proportion.

Under IRS, output rises by a larger proportion than the inputs. So to raise output by some proportion, the firm needs inputs, and so costs, to rise by less. Cost per unit therefore falls.

Option (1) The fixed cost is spread over a larger output, so the cost per unit of output falls. — Incorrect. There are no fixed costs in the long run, so nothing is spread out. This is why AFC falls in the short run.

Option (2) To raise output by a certain proportion, inputs, and so costs, need to rise by a smaller proportion. — Correct. This is what IRS means for cost, with input prices given.

Option (3) The marginal product of the variable input rises as more of it is employed with a fixed factor. — Incorrect. A rising MP with one factor fixed is a short run idea. In the long run all inputs change together.

Option (4) Input prices fall as the firm buys more inputs. — Incorrect. Input prices are taken as given. Cost falls per unit because of how output responds to inputs.

NCERT (2026-27): “Shapes of the Long Run Cost Curves We have previously discussed the returns to scales. Now let us see their implications for the shape of LRAC. IRS implies that if we increase all the inputs by a certain proportion, output increases by more than that proportion. In other words, to increase output by a certain proportion, inputs need to be increased by less than that proportion. With the input prices given, cost also increases by a lesser proportion. For example, suppose we want to double the output. To do that, inputs need to be increased, but less than double. The cost that the firm incurs to hire those inputs therefore also need to be increased by less than double. What is happening to the average cost here? It must be the case that as long as IRS operates, average cost falls as the firm increases output.”

“3.7.2 Long Run Costs In the long run, all inputs are variable. There are no fixed costs. The total cost and the total variable cost therefore, coincide in the long run. Long run average cost (LRAC) is defined as cost per unit of output, i.e. …”