Answer to Question #276470 in Microeconomics for Dikshant

Question

State whether you agree or disagree with the following statements. Give

reasons in support of your answers.

a. A competitive firm will shut down its operations in the short run if it earns losses.

b. The expansion path for a Leontiff production function is linear.

c. If a production function has constant elasticity of substitution (CES), its positive

monotonic transformation will also have CES.

d. A production function that exhibits diminishing marginal returns to inputs, necessarily

has decreasing returns to scale also

Answer 1

a)     I agree that if a competitive firm loses money in the short run, it will shut down operations. A corporation should continue to function as long as its price (average revenue) can cover its average variable costs, according to the shutdown rule. In addition, if the company's overall revenue is less than variable costs in the short term, the company should shut down. Shutting down can reduce variable expenses to zero, but the firm has already paid for fixed expenditures in the near term. As a result, even if the corporation produces no quantity, it will still lose money because it must pay for its fixed expenditures.

b)     I disagree that a Leontiff production function's expansion route is linear. As illustrated in the illustration, the expansion of a linear homogeneous production function is always a straight line across the origin. This indicates that regardless of output levels, the proportions between the factors used will always be the same, as long as the factor prices remain stable.

c)     I agree that a production function with constant elasticity of substitution (CES) will likewise have CES in its positive monotonic transformation. What is the elasticity of replacement for CES technology in general? The elasticity of substitution in the CES function is constant but not necessarily equal to unity. It has a range of 0 to 1. The CD function, on the other hand, is linked to elasticity of one. As a result, the CD function is a subset of the CES function.

d)     I don't believe that a production function with diminishing marginal rewards to inputs must likewise have diminishing returns to scaling. Returns to scale are not incompatible with diminishing returns to a single factor of production. At some level of inputs, all manufacturing processes exhibit diminishing returns to a single factor.