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CMA Foundation · Fundamentals of Business Economics and Management · Cost of Production

A firm doubles all its inputs and its output rises by 60 per cent. Which statement describes this situation?

This is decreasing returns to scale, because doubling all inputs raises output by only 60 per cent, which is less than proportionate. Total cost doubles while output rises 1.6 times, so long-run average cost rises.

  1. AIncreasing returns to scale, so long-run average cost falls
  2. BConstant returns to scale, so long-run average cost stays the same
  3. CDiminishing returns to a variable factor, so short-run marginal cost falls
  4. DDecreasing returns to scale, so long-run average cost risesCorrect

Explanation

Inputs rise 100 per cent but output rises only 60 per cent, a less than proportionate increase. This is decreasing returns to scale. With input prices constant, cost doubles while output rises 1.6 times, so cost per unit rises by 2/1.6 = 1.25 times. Diminishing returns refers to changing one input only, not all inputs.

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