Solution
David answered on
Dec 21 2021
Question 1:
Explain and illustrate with diagrams the differences between diminishing marginal returns and decreasing economies of scale and cite causes and examples.
Ans. Diminishing returns to a variable factor is the decrease in marginal output of production when only 1 factor of production is varied and other factors are kept constant. Adding more of 1 factor, while holding all others constant, will at some point yield lower per unit return. This term is not the same as negative returns. Negative returns are when adding more of a factor will decrease total production. But in diminishing returns, it’s not the total production which decreases but marginal production of output which diminishes. For example in agricultural sector, when land is taken to be fixed, adding more and more fertilizer improves the yield less per unit of fertilizer which is known as diminishing marginal returns to the fertilizer. Similarly, in manufacturing sector diminishing marginal returns to a factor can be seen. At some point, given a fixed factor, adding more workers cause problems such as getting in each other’s way. The marginal product is equal to change in output produced divided by change in input used.
On the other hand, when we are considering returns to scale, which we consider in the long run, all the factors of production are variable. In the long run, all input levels, including physical capital usage are variable. Returns to scale refers to changes in output resulting from a proportionate change in all inputs (when all inputs increase by a constant factor)
When output increases by more than the proportionate change in inputs then there are increasing returns to scale. When output increases by the same proportionate change in inputs then there are constant returns to scale. Lastly when output increases by less than the proportionate change in inputs then the production function exhibits decreasing returns to scale.
Suppose there are two factors of production, K and L, both variable in the long run. Then decreasing returns to scale means F (aK , aL) < a F(K,L) when K and L are increased by the same proportion ‘ a’ in the long run. There are decreasing returns to scale at relatively high output levels. It is shown by rising long run average cost curve.
When there are constant returns to scale, LRAC curve is flat.
Some of the reasons for diseconomies of scale (rising long run average cost curve) are communication costs among employees, duplication of efforts, office politics, difficulty in management of the firm.
Question 2
Suppose the jeans industry is an oligopoly in which each firm sells its own distinctive
and of jeans,and each firm believes its rivals will not follow its price increases but will follow its price cuts.
Draw and explain the demand curve facing each firm, and given this demand curve, does this mean that firms in the jeans industry do or do not compete against one another?
Ans) since there are two firms in the jeans market, each firm is an oligopolist. When one firm increases its price, other doesn’t. But when it cuts price, other also cuts price to increase its own market share. An oligopolist faces a kinked demand curve. It contains two distinct segments- one for higher prices (which gives more elastic demand) and other for low prices which gives less elastic demand curve. There is a co
esponding marginal revenue curve which contains 3 segments. It is relatively flat for elastic demand curve part. It is vertical for kinked part of demand curve. It is relatively steep for less elastic demand part.
Given below is the marginal revenue curve and demand curve for a single oligopolist firm. Similar curves can also be drawn for another firm.
If the marginal cost curve of the firm lies in the vertical region of the MR curve , then price and quantity will be as shown by the kinked point. Suppose now the marginal cost of the firm rises but it still lies in the vertical region of MR curve, then price and quantity sold by the oligopolist firm doesnot change. Even the MC Iincrease will not allow the firm to increase its price. Hence...