Question

Suppose a firm is producing in the long run. When it produces 4,000 units of output, its total cost is $8,000. When it produces 4,200 units of output, its total cost is $8,200, and when it produces 4,400 units of output, its total cost is $8,800. This firm is experiencing (constant, decreasing, increasing, increasing then decreasing, decreasing then increasing) returns to scale?

Answer 1

Answer:

increasing then decreasing

Explanation:

production level            total cost             average total cost

4,000                               $8,000                    $2.00

4,200                               $8,200                     $1.95

4,400                               $8,800                    $2.00

Returns to scale measure the change in productivity, or how much input is needed to produce a unit of output.

• increasing returns to scale: output increases in a greater proportion than inputs
• constant returns to scale: output increases in the same proportion as inputs
• decreasing returns to scale: output increases in a lower proportion than inputs

Since first the average total cost decreased, total output increased in a greater proportion than inputs ⇒ increasing returns of scale. But then the situation reversed and total output increased in a lower proportion than inputs ⇒ decreasing returns of scale.