Suppose a firm increases all inputs by 50% and its output increases by 75%. What type of return to scale is this?
Show answer & explanation
Correct answer: B
Explanation
Correct Answer
Increasing Returns to Scale
Explanation
When analyzing returns to scale, we compare the proportional change in inputs with the change in output. If the increase in output is greater than the proportion of increase in inputs, it is termed as "Increasing Returns to Scale." In this case, the inputs were increased by 50%, whereas the output increased by 75%. Since 75% is greater than 50%, this situation represents increasing returns to scale.
The other options are incorrect because "Constant Returns to Scale" occurs when the increase in output is exactly equal to the increase in inputs (e.g., 50% increase in output from a 50% increase in inputs). "Decreasing Returns to Scale" occurs when the increase in output is less than the increase in inputs.
Key Points
The primary reasons for increasing returns to scale are often "specialization" and "economies of scale" in the production process. As the level of production increases, the firm is able to utilize resources more efficiently, adopt advanced technology, and reduce the cost per unit, which leads to a more-than-proportional increase in production.
Important Questions and Answers
Question: What is meant by "Constant Returns to Scale"?
Answer: When increasing all inputs by a certain proportion leads to an increase in output by the same proportion, it is called Constant Returns to Scale.
Question: What are the common causes for "Decreasing Returns to Scale"?
Answer: Decreasing returns to scale are often observed due to
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