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A firm's average variable cost falls as output rises from zero toward normal capacity but rises steeply beyond it. The rise beyond normal capacity is caused by:
ADiminishing returns to the variable factors
BIncreasing returns to the variable factors
CA continuous fall in total fixed cost
DLong-run economies of scale setting in
Answer & Solution
Correct answer: A. Diminishing returns to the variable factors
1. AVC = TVC / Q and reflects the productivity of variable inputs.
2. Up to normal capacity, increasing returns make each unit cheaper, so AVC falls.
3. Beyond normal capacity, diminishing returns set in, requiring more variable input per unit, so AVC rises steeply.
4. Increasing returns (B) explain the falling part not the rise, fixed cost (C) does not affect AVC, and scale economies (D) are a long-run idea. Hence diminishing returns.
_Source: ICAI BoS CA Foundation Paper 4 Business Economics, Ch 3 Unit II "Theory of Cost", p.6_
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