A solar panel manufacturing company increases all of its production inputs—factory space, machinery, and labor—by . Consequently, its total output of solar panels increases by . At the same time, the chief financial officer argues that the firm cannot lower its unit costs further because fixed capital overhead costs cannot be varied in the long run. Which of the following correctly identifies the firm's returns to scale and evaluates the officer's cost argument?
- The firm is experiencing decreasing returns to scale, and the officer is incorrect because all inputs and costs are variable in the long run.Answer
- BThe firm is experiencing increasing returns to scale, and the officer is correct because fixed overhead costs remain constant across all time horizons.
- CThe firm is experiencing decreasing returns to scale, but the officer is correct because plant capacity constitutes a fixed cost in both short-run and long-run analysis.
- DThe firm is experiencing constant returns to scale, and the officer is incorrect because fixed costs diminish to zero automatically as output expands.
Answer
The firm is experiencing decreasing returns to scale, and the officer is incorrect because all inputs and costs are variable in the long run.
The correct answer identifies that the firm operates under decreasing returns to scale because output expands by , which is less than the proportional increase in all inputs. It also correctly refutes the officer's argument by applying the fundamental economic principle that all inputs—and therefore all costs—are variable in the long run.
Step-by-Step Solution
Key Concept
Long-Run Production and Returns to Scale