Economies of scale refer to the cost advantages that a company can achieve as it increases its production scale. These cost advantages arise because the average cost per unit of output decreases as the level of production increases. In other words, the bigger the scale of production, the lower the cost per unit of output. Therefore, the correct option is when the average cost is falling with output.
As a company increases production, it can spread its fixed costs (such as rent, machinery, and other overhead expenses) over a larger number of units produced, which leads to a decrease in the average cost per unit. Additionally, the company can also negotiate better deals with suppliers due to its larger scale of production, which can further reduce costs. Therefore, companies that can take advantage of economies of scale can become more efficient and competitive in the market.