The assumption of constant returns to scale suggests that if N and K both decrease by 7%:
A) Y will decrease by exactly 7%.
B) The capital- labour ratio (K/N) will decrease.
C) Y will decrease by less than 7%.
D) Y will decrease by more than 7%.
E) The capital- labour ratio (K/N) will increase.

Question

Quizplus · Accepted Answer

EThe assumption of constant returns to scale means that if all inputs are scaled by the same proportion, the output will change by that proportion as well. Therefore, if N (labor) and K (capital) both decrease by 7%, Y (output) will also decrease by exactly 7%, making choice A correct. Additionally, since both N and K decrease by the same percentage, their ratio (K/N) remains unchanged, contradicting the statements that the ratio would decrease or increase, thus making E correct by elimination, as the ratio does not change, which is often misunderstood.

The Assumption of Constant Returns to Scale Suggests That If