PROBLEM #2 Suppose the bicycle shop owner in Problem #1 is looking into expandin

Question

PROBLEM #2 Suppose the bicycle shop owner in Problem #1 is looking into expanding their capacity to repair bicycles, by building an addition to the current repair space, and by purchasing additional equipment to use in the new space. After some careful research, the shop owner learns that the average total cost curve will be generally lower as a result of this additional capital. Based on the owner's findings, determine whether expanding the physical capital and operations results in economies of scale or increasing marginal returns. Briefly explain your answer.

Explanation / Answer

When the bicycle shop owner expands its capacity by purchasing additional equipments and building new repair space, he is doing one time investments and due to this he will now able to provide services to more number of people, thus the average total cost will decrease in the long term as more and more people will come for servicing and the marginal returns will increase.

The economies of scale is possible when the bicycle owner continuously expand its repair space and constantly purchase the equipments with reference to rise in its customers, but here it is just the one time investment, so this will result only in marginal returns or we can say that for economies of scale at least one factor cost is variable.

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