Question 2 When a firm’s production function exhibits constant returns to scale: the short-run average cost...

Question 2

When a firm’s production function exhibits constant returns to scale:

		the short-run average cost curve will be horizontal.
		the long-run average cost curve will be U-shaped.
		the long-run marginal cost curve will be upward sloping.
		the short-run average variable cost curve will be downward sloping.
		the long-run average cost curve will be horizontal.

Expert Solution

There are two types of production functions. They are variable proportion and returns to scale. The variable proportion applies to shortrun and the returns to scale are applicable to the longrun. Under variable proportion, units of fixed factors remain constant and units of variable factors are changing. But under returns to scale all factors are changing. Increasing returns, diminishing returns and negative returns are associated with variable proportion. But increasing returns, constant returns and decreasing returns are associated with the returns to scale.

When a firm is experiencing increasing returns to scale the average cost fall as output increases. Then the average cost curve will be downward sloping. If the production function exhibits constant returns to scale, the average cost will be the same for all output level. Thus the average cost curve will be a horizontal. Again when there is decreasing returns to scale the average cost will be increasing with increasing output level. All these returns together gives the shape of an envelope to the longrun average cost curve.

Answer: the longrun average cost curve will be horizontal.

Rahul Sunny answered 2 years ago

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