Question

Imagine yourself a producer (in a perfectly competitive market structure), focusing on profit maximisation. Will you prefer striking an equilibrium in a state of increasing returns?

Answer 1

Striking an equilibrium in a state of increasing returns to a factor (when $MP$ is rising or $MC$ is falling) is absolutely ruled out. Because it is a situation when every additional unit of output adds more and more to total profits. Reason: While $MR$ is constant (under perfect competition) $MC$ is falling (owing to increasing returns), so that the difference between $MR$ and $MC$ tends to rise. It is only when the difference $(MR-MC)$ starts shrinking, and is finally eliminated, that the profits are maximised. This happens only in a state of diminishing returns when $MP$ is falling or $MC$ is rising.