Question

3) This question has two parts: Do you agree or disagree with each of the following statements? Explain your answers fully (no graphs needed). a) If a firm’s revenues do not cover its costs then it makes economic sense for the firm to quit immediately. b) Increasing returns to scale refers to a situation where an increase in a firm’s scale of production leads to higher costs per unit produced. [Make sure your answer clearly defines the term “returns to scale”.]

Answer 1

A) I disagree with the statement because firm's quitting decision or shut down decision depends on which cost it's total revenue is covering. If TR is less than Total cost but greater than Total variable cost, it means, ATC > Price > AVC, then the firm incurs an economic loss that is less than fixed cost and produces a quantity that equates MR and MC. In this case firm will not shut down. But if, TR < TVC, that is, P < AVC, then the firm shuts down in short run because it incurs an economic loss = Total fixed cost.

B) I disagree with the statement. Increasing return to scale refers to a situation where a firm's long run average cost is falling and therefore an increase in firm's scale of production leads to lower costs per unit produced.