This section consists of a discussion of the validity of the assumption, made in the previous section, that production has decreasing returns to scale, namely increasing marginal and average cost, and diminishing marginal and average product, as the scale of production increases.
Hicks lists two considerations that sometimes lead to criticism of the assumed conditions. One consideration is "the frequent conviction of entrepreneurs themselves" that they have decreasing average costs. The other consideration is that of indivisibility of certain types of investment in factors of production.
Hicks explains that for short-run problems, the existence of "fixed equipment or plant of the firm, which has been built up in the past, and is likely to be to some extent unique" can cause a situation of a factor of production being combined with resources that the firm cannot purchase on the open market. He argues that this kind of situation can tend to cause diminishing returns, or increasing costs.
For long-run problems, the argument for increasing marginal cost follows from "the increasing difficulty of controlling an enterprise, as its scale of production grows."
Hicks devotes the final paragraph of the section to discussing the implications of having conditions on both marginal cost and average cost. As he notes, "Marginal costs must rise as the firm expands, in order to ensure that its expansion stops somewhere." But this condition alone is not enough to specify where the expansion stops. The firm can be expected to sell at a price equal to marginal cost, but this marginal cost must not be too close to its minimum; otherwise marginal cost would be below average cost, and the firm would be selling at a loss.
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