A firm doubles all its inputs in the long run, and its output becomes 2.5 times the earlier output. Input prices are given. Which chain is correct?
Answer & explanation
Correct answer: option 1
The correct answer is Option (1) → Increasing returns to scale → to double output, cost rises by less than double → LRAC falls
Inputs double but output becomes 2.5 times, so output rises by a larger proportion: this is increasing returns to scale. To double output, the firm then needs less than double the inputs, so cost rises by less than double and average cost falls.
Option (1) Increasing returns to scale → to double output, cost rises by less than double → LRAC falls — Correct. Each link follows from IRS.
Option (2) Constant returns to scale → cost doubles with output → LRAC stays the same — Incorrect. Under CRS, output would only double, not become 2.5 times.
Option (3) Decreasing returns to scale → to double output, cost rises by less than double → LRAC falls — Incorrect. Under DRS, output would rise by less than double, and cost would rise by more than double.
Option (4) Increasing returns to scale → to double output, cost must more than double → LRAC rises — Incorrect. The first link is right, but under IRS cost rises by less than double, so LRAC falls.
NCERT (2026-27): “3.6 Returns to Scale … When a proportional increase in all inputs results in an increase in output by the same proportion, the production function is said to display Constant returns to scale (CRS). When a proportional increase in all inputs results in an increase in output by a larger proportion, the production function is said to display Increasing Returns to Scale (IRS) Decreasing Returns to Scale (DRS) holds when a proportional increase in all inputs results in an increase in output by a smaller proportion. For example, suppose in a production process, all inputs get doubled. As a result, if the output gets doubled, the production function exhibits CRS. If output is less than doubled, then DRS holds, and if it is more than doubled, then IRS holds.” “Shapes of the Long Run Cost Curves We have previously discussed the returns to scales. Now let us see their implications for the shape of LRAC. IRS implies that if we increase all the inputs by a certain proportion, output increases by more than that proportion. In other words, to increase output by a certain proportion, inputs need to be increased by less than that proportion. With the input prices given, cost also increases by a lesser proportion. For example, suppose we want to double the output. To do that, inputs need to be increased, but less than double. The cost that the firm incurs to hire those inputs therefore also need to be increased by less than double. What is happening to the average cost here? It must be the case that as long as IRS operates, average cost falls as the firm increases output.” |