Answer to Question #251278 in Economics for Marsha

Question

In the production or operations process a large variety of production means are combined in order to produce the planned output(s). When the ratios between combinations of production means are changed, the magnitude of the output which is produced therewith usually also varies. This phenomenon is the result of the operation of the law of diminishing marginal returns. Discuss in full the operation of the law of diminishing marginal returns including its relationship with economies of scale. 

Answer 1

The law of diminishing marginal returns is a theory in economics that predicts that, after reaching some optimal level of capacity, adding an additional factor of production will actually result in a smaller increase in output.

For example, a factory hires workers to manufacture its products, and at some point, the company is operating at its optimal level. With all other factors of production unchanged, the addition of additional workers beyond this optimal level will reduce the efficiency of operations.

A decrease in marginal returns is a consequence of an increase in costs in the short run, while at least one production variable remains constant, such as labor or capital. On the other hand, returns to scale are the result of cost increases across all production variables in the long run. This phenomenon is called economies of scale.

For example, suppose there is a manufacturer who can double his total input but receives only a 60% increase in total output; this is an example of diminishing returns to scale. Now, if the same producer doubles its total output, then it will achieve constant returns to scale, where the increase in output is proportional to the increase in production costs. However, economies of scale will occur when the percentage increase in output is greater than the percentage increase in costs (so that when costs are doubled, the output will triple).