Question

 

Explain and draw total cost, average cost, Marginal cost for decreasing returns to scale.

Answer 1

Note that the decreasing returns to scale occur when an increase in all the inputs of a firm causes a less than a proportional decline in the output. If we understand the costs in this scenario, then the increase in the costs is higher than the increase in output because now a larger amount of inputs are required to produce a given amount of output. Hence, in this case, the long-run average total cost is upward sloping and so are the other cost curves. Note that the long-run average cost curve is formed using the short-run average cost curves over a period of time. If we consider the following graph, note that the phase after the efficient production level (the output level where the average costs of production will be the least) implies the diseconomies of scale or decreasing return to scale.

The individual curves are also presented in the above graph which only considers the upward sloping part of the cost curves. Note that the marginal cost curve, in the long run, cuts the long-run average and total cost curves at their lowest.