When a firm increases all the factors of production by a factor and output increases by a smaller factor. As a result this causes the firm's average cost to rise.
Below is an illustration of how a business would achieve decreasing returns to scale. Assuming this firm only uses capital and labour as its inputs. A doubling of the capital and labour input leads to a lower than two-fold increase in output. Because the average cost is calculated by the total costs/output, if the costs are increasing quicker than output, average costs are rising.
