Question

"If a firm has diminishing returns to labor over some range of output, it cannot have economies of scale over that range." True or false? Explain briefly.

Short answer

False. A firm can have diminishing returns to labor over some range of output and still achieve economies of scale over that range.

Step-by-step solution

Understanding Key Concepts

Diminishing returns to labor refers to a situation where, as more labor is added to the production process, the marginal product of labor decreases. On the other hand, economies of scale occur when a firm increases its scale of production and the average cost per unit of output decreases.

Relating Two Concepts

Now, we need to understand how these two concepts relate. Diminishing returns to labor is a concept applied in the short run when capital is fixed. It is more focused on the per unit change from increasing one factor of production, labor in this case while holding other factors constant. Meanwhile, economies of scale is a long run concept and involves all factors of production. It discusses the percentage change in input leading to a greater percentage change in output.

Formulating the Answer

The assertion in the exercise is false. A firm can have diminishing returns to labor over some range of output and still achieve economies of scale over that range because the scale of an entire operation is broader in scope and encompasses more variables than labor alone. While additional labor may contribute less to output, simultaneously the average cost per unit may decrease due to more efficient processes, better management, or other factors, leading to economies of scale.