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A firm uses two inputs, capital (KO) and labor (D), to produce output
A firm uses two inputs, capital (KO) and labor (D), to produce output. Assume that the marginal product of labor and the marginal product of capital are always greater than zero. The figure below displays two isoquants from the firm's production function. The bundle (L = 1. K = 1) falls on the q=1 isoquant li.e. all bundles on the curve result in one unit of output). The bundle ( L3, K = 2 talls on the q = 2 isoquant. Given this information, which statement below is true? K 2 92 1 O 3 (Note: If no image appears above, click here) The production function exhibits constant returns to scale The production function exhibits increasing returns to scale The production function exhibits decreasing retums to scale There is not enough information available to say which of the above statements is true
Expert Solution
Ans.- (C)
Decreasing returns to scale occurs when an increase in all inputs together leads to a less than proportional increase in the output produced ( e.g. inputs increase 4 times but output increases only 2 times).
Here,
When L=1 and K= 1, then 1 unit is produced.
When L= 3 and K= 2, then 2 units are produced
However, if inputs are doubled from initial input level i.e. if L= 2 and K= 2, then less than 2 units of output will be produced since this isoquant will lie between the given isoquants and therefore a doubling of inputs leads to a less than double increase in output level. Thus, there are diminishing returns to scale.
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