When production is added to an exchange economy, which of the following assumptions is not needed?
A)Production functions exhibit increasing returns to scale.
B)Isoquants are smooth and convex.
C)Production involves no externalities.
D)Both inputs are essential for both goods.

Question

Quizplus · Accepted Answer

The assumption that production functions exhibit increasing returns to scale is not needed when adding production to an exchange economy. Typically, production functions are assumed to exhibit constant or decreasing returns to scale to ensure competitive equilibrium models work properly. Increasing returns to scale can lead to monopolies and other market failures, which complicates the analysis of exchange economies.

When Production Is Added to an Exchange Economy, Which of the Following