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IAI Actuarial Core Principles · Business Economics · Production, costs, revenue and profit in price and output decisions

A Chennai insurer's claims-processing unit has the long-run average cost curve of a typical firm. After output doubles, its long-run average cost rises from ₹80 to ₹92 per policy because coordination across offices becomes harder. Which statement is correct?

The unit faces diseconomies of scale because long-run average cost rises from ₹80 to ₹92 as output expands, owing to coordination difficulties. Diminishing returns is a short-run idea with a fixed factor, so it does not apply to the long run.

  1. AThe unit faces economies of scale, since output has doubled
  2. BThe unit faces diseconomies of scale, since long-run average cost rises with outputCorrect
  3. CThe unit faces diminishing marginal returns, since some factors are fixed in the long run
  4. DThe unit faces constant returns to scale, since cost per policy changed by under 20%
  5. The unit's fixed costs have risen, which defines diseconomies of scale

Explanation

Diseconomies of scale mean long-run average cost rises as output expands, here from ₹80 to ₹92, owing to coordination problems. Diminishing returns is a short-run concept with a fixed factor, and no factor is fixed in the long run. Constant returns would leave average cost unchanged.

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