Increasing return may occur in long run. Which of the following may be the reason for the same?
A. Comparative advantage. B. Law of diminishing returns. C. Price ceilings. D. Economies of scale.
The correct answer and explanation is:
The correct answer is D. Economies of scale.
Explanation:
In the long run, increasing returns to scale can occur due to economies of scale. Economies of scale refer to the cost advantages that firms experience as their production scale increases. As a company produces more output, the cost per unit of output typically decreases. This happens because fixed costs (such as capital investment, machinery, and management) are spread over more units of output, leading to a reduction in the average cost of production.
When a company expands its production, it can negotiate better rates for inputs, utilize its production capacity more efficiently, and invest in specialized technologies. As a result, production becomes more efficient and the marginal cost of producing each additional unit decreases. These benefits lead to increasing returns in the long run.
For instance, in manufacturing industries, as production increases, firms can invest in more advanced machinery or take advantage of bulk purchasing, which reduces per-unit production costs. Similarly, firms may benefit from specialization in labor, where workers focus on specific tasks they perform repeatedly, thus improving productivity and reducing inefficiencies.
On the other hand, the law of diminishing returns (option B) applies in the short run when adding more of one factor of production (like labor) while keeping others constant (like machinery) results in progressively smaller increases in output. However, this phenomenon typically does not apply to the long run, where firms can adjust all inputs to optimize production.
Comparative advantage (option A) refers to the ability of a firm or country to produce a good or service at a lower opportunity cost than others, which is related to trade and resource allocation but does not directly explain increasing returns to scale.
Price ceilings (option C) are government-imposed limits on prices that prevent them from rising above a certain level. While they can impact market outcomes, they do not directly contribute to increasing returns to scale.