Question

If bagel shop has decreasing returns to scale:

In the short run - how would the shop react to an increase in the output price (p)? a decrease in wage (w)?

In the long run - how would the shop react to an increase in capital (r)?

(i.e., how would the supply curve, profit-max. labor demand shift, input choice? Draw a diagram if possible)

Answer 1

Decreasing returns to scale is situation where increase in output is less than the increase in input. For eg increase in labour by 30% there will be only 20 % increase in output.

In the above case of bagel shop has decreasing returns of scale where it they increase price of output which means what they were producing earlier was being sold at 40dollars but now they are selling it for 60 dollar, so this will help them to cover the input cost of the company.

Now impact of decrease in wages, in general decrease in wages will always reduce the cost of production which means it will have positive impact on the bagel shop

Increase in capital will lead to increase input in short term and as shops condition of decreasing returns to scale it will increase the cost and have negative impact on shop. But in long run company becomes stablized and all the factor become variable in the company so even if the company is increasing their capital it won't be affecting much on them because now they can afford to bear the cost.