Question

Assume that a firm’s production function exhibits decreasing returns to scale.

a)Long run marginal cost (LRMC) is always equal to LRAC

b) LMRC is always lower than LRAC

c)LMRC is always higher than LRAC

d)none of the previous is correct

Answer 1

Since decreasing return to scale occurs when Long-run marginal cost curve is increasing with the increase in the output level.

Since Total cost is the sum of all marginal cost.

LRAC=LRTC/Q

Hence when MC increases, the long-run total cost increases and with the increase in the long-run total cost, the long-run average cost also increases (LRAC). Therefore decreasing return to scale happens.

Hence it can be said that when  a firm’s production function exhibits decreasing returns to scale LMRC is always higher than LRAC.

Hence option C is the correct answer.