What happens to average costs as production output increases?

As production output increases, average costs typically fall because fixed costs are spread over more units of output. Fixed costs are expenses that do not change with the level of production, such as rent or salaries. When a company produces more units, these fixed costs are divided among a larger number of goods, resulting in a lower average cost per unit.

For example, if a factory incurs $1,000 per month in fixed costs and produces 100 units, the average fixed cost per unit is $10. However, if the factory increases production to 200 units, the average fixed cost per unit drops to $5. This effect of spreading fixed costs over a larger production volume is often referred to as "economies of scale," which contributes to lower average costs as output increases.

This principle is fundamental in production economics, as it illustrates how production efficiency can be achieved as businesses grow.