Question

Suppose that in the isoquant-isocost diagram, with given relative factor prices, an ut combination of 10 units of capital and 30 units of labor yields an output 2 of 18 m of 120 units. Suppose that, for this firm, at the same relative factor a larger budget, an equilibrium input combination of 15 units of capital and 45 units of labor yields an output level of 160 units. Viewing these input-output relationships, an economist would say that, in its production process, this firm experiences a. increasing returns to scale. b. constant returns to scale. c. decreasing returns to scale. d. increasing returns to scale, constant returns to scale, or decreasing returns to scale - cannot be determined without more information. 4. If, for a consumer, (MUN/PA) is greater than (MUB/PB), then the consumer a. has an incentive to consume relatively more of good A, which will increase his/her MUA b. has an incentive to consume relatively more of good A, which will decrease his/her MUA c. has an incentive to consume relatively more of good B, which will increase his/her MUB. d. has an incentive to consume relatively more of good B, which will decrease his/her MUB.

Answer 1

(3) (c)

Increase in labor = 45/30 = 1.5 times

Increase in capital = 15/10 = 1.5 times

Increase in output = 160/120 = 1.33 times

Since increasing both inputs by 1.5 times has increased output by less than 1.5 times, there is decreasing return to scale.

(4) (c)

Utility is maximized when (MUA / PA) = (MUB / PB)

When (MUA / PA) > (MUB / PB), the consumer should consume less of A (to decrease MUA) and more of B (to increase MUB).