Question

Consider a competitive firm operating in the short run with a production technology that uses a single variable factor that exhibits increasing then diminishing marginal productivity. Over the range of output where the marginal cost of producing output exceeds the average variable cost of producing output, then which of the following must be necessarily true in the short run? a) Average fixed costs (AFC) are increasing. b) Marginal costs (MC) are increasing. c) Average variable costs (AVC) must be decreasing as the firm produces more output. d) The average product of labour must be increasing. e) The firm’s production technology exhibits decreasing returns to scale. Please provide explanation

Answer 1

We have the following information

• There are increasing then diminishing marginal productivity.
• This implies that MC ATC and AVC all are U-shaped.
• When MC > AVC and ATC, both AVC and ATC are rising and when MC < AVC and ATC, both AVC and ATC are falling

Over the range of output where the MC > AVC,  AFC is decreasing and is decreasing otherwise also because it is a decreasing function of output. MC must be rising because when it is greater than AVC, AVC is rising, implying that it has surpassed its minimum level. APL is decreasing since we have diminishing marginal productivity and when MC and AVC are rising, MPL and APL are falling.

Select b) Marginal costs (MC) are increasing.