Question

Given a Cobb-Douglas production function estimate of Q = 1.19L⁰·⁷²K⁰·¹⁸ for a given industry, this industry would have:

1) increasing returns to scale
2) constant returns to scale
3) decreasing returns to scale
4) negative returns to scale
5) none of the above

Answer 1

The Cobb-Douglas production function estimate with exponents of labor and capital adding up to less than 1 indicates decreasing returns to scale.

Step-by-step explanation:

In the case of the Cobb-Douglas production function estimate Q = 1.19L0.72K0.18, we determine the returns to scale by adding the exponents of labor (L) and capital (K). Here, 0.72 + 0.18 equals 0.9, which is less than 1. This indicates decreasing returns to scale, meaning that as the inputs increase, the output increases but at a diminishing rate. A clear sign of constant returns to scale in an industry is when the long-run average cost (LRAC) curve remains flat as the output quantity increases around a certain point (Q3), meaning average costs do not change substantially as scale rises or falls. This is not the case with the given production function since the sum of the exponents does not equal 1.