"If constant returns to scale exist for a firm, then a 10 percent rise in all factor prices will lead to a 10 percent decline in the equilibrium quantity of output for a given budget. However, if increasing returns to scale exist, a 10 percent rise in all factor prices will lead to a less than 10 percent decline in the equilibrium quantity of output for a given budget."Assess the validity of this statement.

Question

Quizplus · Accepted Answer

The Answer is The statement is not entirely valid.

If constant returns to scale exist for a firm, then a 10 percent rise in all factor prices will lead to a less than 10 percent decline in the equilibrium quantity of output for a given budget. This is because with constant returns to scale, the firm can adjust its input levels to minimize the impact of the price increase on output quantity. It may be able to find cost-saving measures or alternative inputs to maintain or even increase output quantity.

On the other hand, if increasing returns to scale exist, a 10 percent rise in all factor prices may indeed lead to a less than 10 percent decline in the equilibrium quantity of output for a given budget. This is because with increasing returns to scale, the firm experiences economies of scale as it produces more output, which can offset some of the cost increase from the factor prices.

In both cases, the impact of a 10 percent rise in all factor prices on the equilibrium quantity of output will depend on the specific production function and cost structure of the firm. It is not necessarily a direct 10 percent decline in output quantity for a given budget in either scenario. Therefore, the statement oversimplifies the relationship between factor prices and output quantity in the context of returns to scale.

"If Constant Returns to Scale Exist for a Firm, Then