Answer to Question #143778 in Macroeconomics for Bakary S Dibba

Question

1. 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, theproduction function is said to exhibit increasing returns to scale. Why might a production function exhibit decreasing or increasing returns to scale?

Answer 1

Production function can exhibit increasing returns to scale due to economies of scale. If production is done on large scale that per unit labour and capital is less and it contributes more to output.

Production function can exhibit decreasing returns to scale due to dis-economies of scale, where every unit of labour and capital does not increase output by the same proportion.