Question

A firm owns a plant with a capacity of producing 2M pens per year, but currently it operates at 50% of its capacity (making 1M pens per year) with average cost being 90 cents per pen . The forecast is that next year the sales volume will be around 1.2M. The firm could raise production volume to meet the demand, by operating at 60% of its full capacity so that average cost is 85 cents per pen.

This is an example of short-run economies of scale because increased capacity utilization, unlike technology adoption, usually can be achieved in the short-run and lowers average cost as fixed cost is spread over more units. Is this statement true?

A) True

B) False

Answer 1

Economies of Scale refer to the cost advantage experienced by a firm when it increases its level of output/ Economies of scale can be implemented by a firm at any stage of the production process.

Economies of scale reduces the per unit fixed cost. As a result of increased production, the fixed cost gets spread over more output than before.

Answer: True