Question

If a 10 percent increase in both capital and labor causes output to increase by less than 10 percent, the production function is said to exhibit decreasing returns to scale. If it causes output to increase by more than 10 percent, the production function is said to exhibit increasing returns to scale. Why might a production function exhibit decreasing or increasing returns to scale?

Answer 1

Because of economies and diseconomies of scale.

Step-by-step explanation:

Increasing returns to scale refers to the situation when a proportionate change in input leads to more than proportionate change in output. This may happen because of economies of scale.

Economies of scale are said to happen when the average cost of production decreases with the increase in the volume of output.

Decreasing returns to scale refers to the situation when a proportionate change in input leads to less than proportionate change in output. This may happen because of diseconomies of scale.

Diseconomies of scale occur when a firm experiences an increase in the average total cost as the volume of output increases.