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

A firm's long-run average cost (LRAC) per unit at different output levels is: 1,000 units Rs 50; 2,000 units Rs 40; 3,000 units Rs 40; 4,000 units Rs 45. Over which range of output does the firm experience constant returns to scale, and what happens beyond it?

Average cost falls to Rs 40 at 2,000 units, stays at Rs 40 up to 3,000 units, and then rises to Rs 45 at 4,000 units. So constant returns apply between 2,000 and 3,000 units, and diseconomies of scale appear beyond 3,000 units.

  1. AUp to 2,000 units, after which diseconomies set in immediately
  2. BBetween 2,000 and 3,000 units; beyond 3,000 units diseconomies of scale appearCorrect
  3. CBetween 1,000 and 2,000 units; beyond 2,000 units average cost is constant
  4. DBetween 3,000 and 4,000 units; before 3,000 units diseconomies exist

Explanation

LRAC falls from Rs 50 to Rs 40 up to 2,000 units, so economies of scale operate. It stays at Rs 40 between 2,000 and 3,000 units, so returns are constant there. It rises to Rs 45 at 4,000 units, showing diseconomies. The option placing constancy after 2,000 units ignores the rise to Rs 45.

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