National Evaluation Series (NES) Business Studies Practice Test

When are economies of scale likely to be greatest for a company?

1. When variable costs decrease

2. When fixed costs change with production

3. When fixed costs remain constant

4. When all costs increase

The correct answer is: When fixed costs remain constant

Economies of scale occur when a company's production efficiency increases as the volume of production rises, leading to a decrease in average costs per unit. This phenomenon is primarily influenced by the behavior of fixed and variable costs. When fixed costs remain constant, the company can spread these costs over a larger number of units produced as production increases. For example, consider a factory with a set cost for rent, machinery, and salaries for management. These fixed costs do not change regardless of the number of units produced. As the output increases, the fixed costs per unit decrease, which allows the average cost of production to fall significantly. This effect is a key driver of economies of scale. In contrast, if fixed costs change with production—such as if the company needs to buy more equipment or hire more staff to increase production—then the potential for achieving economies of scale is diminished. Similarly, variable costs increasing would impact the average cost adversely, as these costs are directly tied to the production level. Lastly, a general increase in all costs would negate the benefits of economies of scale, especially if the increases apply to both variable and fixed costs during higher production levels. Thus, the scenario where fixed costs remain constant leads to the most significant potential for economies of scale, allowing