A firm currently employs five units of capital. When the firm adds a s

A firm currently employs five units of capital. When the firm adds a sixth unit of capital, it is able to reach a lower average cost for a greater quantity of output.

What does this tell you about the shape of the long-run average cost curve and are economies of scale occurring? Explain briefly. Does this necessarily imply increasing or decreasing returns to scale in production or is it ambiguous? Explain briefly.

ANSWER

Because the average cost is decreasing as the firm increases output, the long-run AC is falling and the firm is experiencing economies of scale. Returns to scale is ambiguous. While IRTS imply EOS, EOS can occur even in the presence of DRTS or CRTS.