If a firm’s long-run average total cost increases by 6% when output is increased by 6%, the firm is experiencing: A. economies of scale. B. diseconomies of scale. C. constant returns to scale. Answer is B, at a glance I thought it was C because it looks more intuitive, but I still can’t figure out why it is diseconomies of scale. Anyone mind helping me out?
Constant returns to scale has nothing to do with economies of scale or diseconomies of scale. It means that if you increase both labor and capital by a given percentage, output increases by that same percentage. It’s usually used in conjunction with the Cobb-Douglas production model that you see at Level II and Level III.
Here, an increase in production results in an increase in average total cost; that’s the definition of diseconomies of scale. If an increase in production results in a decrease in average total cost, you have economies of scale. It’s just the definitions of those terms.
Note that the two 6% numbers are red herrings: the only thing that matters is that they are both increases, not their magnitudes.
Very useful, thanks!
You’re quite welcome.