Question

Explain why this false:

A particular firm has decreasing returns to scale at all levels of output. If it was divided into two smaller firms that each use exactly half the amount of all inputs compared to the original firm (but are otherwise identical), and prices remained constant, the combined profits of the two smaller firms would be less than the profit of the original firm.

Answer 1

The statement given above is false because when the firm is divided into two identical smaller firms which are using exactly half the amount of inputs compared to the original firm and the prices in the market are constant then, in that case, the profit will not be less than the original firm but equal to it.

For example, one large firm was using an input of $90 and earning a profit of $10. When divided into two smaller firms with identical cost and input the profit will also get divided into two equal parts and the sum will be equal or even more than the original firm because the two smaller firm may not have reached the point of decreasing return in production.