Examkin

Question

Difficulty: Very hardScales of Production and Economies of Scale

A commercial flour milling enterprise located in an industrial estate in Kaduna increases all of its production inputs—both capital and labor—by 100%100\%. Due to internal managerial communication bottlenecks and operational delays, total output increases by only 65%65\%. Concurrently, the regional government constructs a shared high-capacity grain silo and transport infrastructure hub that reduces raw material storage and freight costs for all milling firms operating in that industrial estate. Which of the following statements correctly categorizes the firm's internal production relationship and the cost benefit derived from the regional infrastructure?

  1. The firm experiences internal decreasing returns to scale, while benefitting from external economies of scale.Answer
  2. B
    The firm experiences internal increasing returns to scale, while benefitting from external economies of scale.
  3. C
    The firm experiences short-run diminishing marginal returns, while benefitting from internal economies of scale.
  4. D
    The firm experiences internal decreasing returns to scale, while benefitting from internal economies of scale.

Answer

The firm experiences internal decreasing returns to scale, while benefitting from external economies of scale.
The correct answer identifies that doubling all inputs (100%100\%) leads to a less-than-proportional increase in output (65%65\%), which by definition represents internal decreasing returns to scale. Furthermore, cost advantages arising from public infrastructure provided to an entire industrial cluster represent external economies of scale.

Step-by-Step Solution

1
Analyze the long-run input-output relationship of the firm
Inputs (capital and labor) increase by 100%100\%, whereas output increases by 65%65\%.
When all inputs change in equal proportion in the long run and the resulting percentage change in output is less than the percentage change in inputs (%ΔOutput<%ΔInputs\% \Delta \text{Output} < \% \Delta \text{Inputs}), the firm exhibits decreasing returns to scale (diseconomies of scale internally).
2
Analyze the cost advantage resulting from the shared grain silo and logistics hub
The cost reductions apply to all milling firms operating within the industrial estate due to industry localization and government infrastructure.
Cost reductions that accrue to an entire industry or cluster of firms as a result of external factors (such as regional infrastructure or localization of industry) are classified as external economies of scale.
3
Synthesize the internal and external cost dynamics
The firm exhibits internal decreasing returns to scale combined with external economies of scale.
Combining the firm-specific input-output ratio with the industry-wide external cost savings yields this exact classification.

Key Concept

Returns to Scale and Internal vs. External Economies of Scale
Rate this question

Topics

Scales of Production and Economies of Scale

More questions from this topic