Question

1- If a firm experiences diminishing marginal productivity, does this imply that they experience diseconomies of scale? Explain.

2- Allocative efficiency in perfectly competitive markets depends on the assumption that marginal cost to firms equals marginal cost to society. Using gasoline as an example, what might be some social costs that are not included in the marginal cost to the firm? Explain.

Answer 1

1)

The diminishing marginal productivity means that additional use of input, leads to marginal rise in the output. In other words, when we use additional inputs, due to the diseconomies of scale, the diminishing marginal return will happen here.

2)

The allocative efficiency is achieved where marginal cost is equal to the social marginal cost. marginal cost includes the private marginal cost Plus the marginal external cost.

In case of gasoline there is external marginal cost, it is not included in the marginal cost.

Thus here over production occurs . The marginal external cost must be considered to produce the allocatively efficient output.