Refer to the long-run cost diagram for a firm. If the firm produces output Q2 at

Question

Refer to the long-run cost diagram for a firm. If the firm produces output Q2 at an average cost of ATC3, then the firm is

Multiple Choice

a.incurring X-inefficiency and is failing to realize all existing economies of scale.

b.incurring X-inefficiency but is realizing all existing economies of scale.

c.producing that output with the most efficient combination of inputs and is realizing all existing economies of scale.

d.producing the profit-maximizing output but is failing to minimize production costs.

Explanation / Answer

Answer

The correct option is (c) Producing that output with the most efficient combination of inputs and is realizing all existing economies of scale.

Lets begin with how long Run Cost Function is determine .

Min : vK + wL

Given Q(K,L) = Q'

In this case Q' = Q2

And ATC = TC/Q

Hence At any point on ATC best combination of Input has been choosen because TC is derived by minimizing the cost.

Corresponding to Q = Q2,Our ATC must equals ATC3 hence and in our question it is equal to ATC3. Hence output is produced with the most efficient combination of inputs

Economies of Scale means with increase in production Cost per unit of output is decreasing or ATC is decreasing). As we can see from above graph that at Quantity = Q2 , ATC is minimum(ATC3) and if we further increase our output (Output>Q2), ATC is increasing Hence It is realizing all existing economies of scale.

Hence The correct option is (c)

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