Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What causes the average variable cost curve to decline?

1. Increased labor costs

2. Diminishing returns on production

3. Economies of scale

4. Fixed costs increasing

The correct answer is: Economies of scale

The average variable cost (AVC) curve declines primarily due to economies of scale. As production increases, firms often benefit from operational efficiencies that arise when spreading fixed costs over a larger number of units. This means that the additional output often results in a lower cost per unit for variables as well, due to more efficient use of labor and materials. When firms can produce more without a proportionate increase in variable costs, the average variable cost per unit decreases. In this context, factors like increased labor costs, diminishing returns on production, and increasing fixed costs typically exert upward pressure on average variable costs. Increased labor costs would lead to higher AVC if wages rise without a corresponding increase in productivity. Diminishing returns on production indicate that as more units are produced, the additional output per unit of input decreases, which typically raises the average costs. Similarly, if fixed costs increase, they do not directly affect the variable portion but can lead to an increase in total costs, thus impacting the average cost calculations differently.