Suppose an economy has the production function Y = A × K¹/⁴ × H³/⁴,where Y denotes total output,A denotes the level of technology,K denotes the physical capital stock,and H denotes the efficiency units of production.Which of the following is true of this economy?
A) Production in this economy exhibits increasing returns to scale.
B) Production in this economy exhibits constant returns to scale.
C) Production in this economy exhibits decreasing returns to scale.
D) Production in this economy decreases when the price level increases.

Question

Quizplus · Accepted Answer

By checking the exponents of K and H in the production function, we can see that if both inputs increase by a factor of λ, output increases by a factor of A(λ^¼)×(λ³/⁴)=Aλ. As λ is greater than 1, output increases more than proportionally with input increases. Therefore, this production function exhibits increasing returns to scale. However, we also know that total output increases with a constant rate for both K and H, implying that the production function exhibits constant returns to scale. Therefore, the correct answer is B. The production function does not tell us anything about how output might change as a result of a change in the price level.

Suppose an Economy Has the Production Function Y = a ×