Question

With capital fixed at one unit with 1, 2, 3 units of labor added in equal successive units, production of the output increases from 300 (1 unit of labor), to 350 (2 units of labor) to 375 (3 units of labor). Which of the following is a correct interpretation?

           a. This is long run increasing returns to scale

           b. This is long run decreasing returns to scale

           c. This is long run constant returns to scale

           d. This is short run diminishing marginal productivity

           e. This is short run increasing marginal productivity

Answer 1

In order to deter mine returns to scale we have to increase all inputs by same proportion and then check there effect on output. But here Capital is fixed. So definite we cannot say anything about returns to scale. More over because Capital is fixed and in long run all inputs are variable so this is definitely a short run. Hence option (a) , (b) and (c) are incorrect.

Marginal productivity is the additional output produces when we increase amount of input(here Labor) by 1 unit.

When Labor increases from 1 to 2, then output increased from 300 to 350 and hence Marginal product of 2nd unit of labor = 350 - 300 = 50

When Labor increases from 2 to 3, then output increased from 350 to 375 and hence Marginal product of 3rd unit of labor = 375 - 350 = 2.

Thus Marginal productivity decreases and thus it is having diminishing marginal productivity and note that capital is fixed, so it is a short run. Hence, option (d) is correct and (e) is incorrect.

Hence, the correct answer is (d) This is short run diminishing marginal productivity.