What is the difference between diminishing returns and decreasing returns to scale

Need help with Economics? One to one online tuition can be a great way to brush up on your Economics knowledge. Answered by Shivani S. Answered by Natalie K. Answered by Timothy W. Answered by Lewis H. Payment Security. They can negotiate good deals with their wholesalers too, whereas smaller firms would have to buy and sell at the market price. The financial economies available to large firms are due to the interest rate on large bank loans being lower, as a large company can secure the loan and is therefore a lower risk.

This means that when large firms need to borrow money for investment, they can do so more easily. All of these increasing returns to scale mean that as a firm grows the long run average cost curve falls, so the firm is becoming more efficient and can produce at a lower cost.

However, as the firm continues to grow, it may start to experience decreasing returns to scale. They are mainly incurred when a firm has to coordinate production in a large factory, as the whole factory has to be controlled by a central team of managers. Thus production may begin to break down due to poor coordination of resources, which will raise costs, or be prevented by an increase in managers, which will also increase costs.

For very large outputs, these problems will dominate, and any economies of scale achieved by the firm will be overridden. However, this managerial breakdown may be because as the firm has grown and the factors of production have increased the number of managers has not increased by the same proportion. In practice, this makes decreasing returns to scale hard to justify, so it remains a theoretical concept. The main differences between the law of diminishing returns and returns to scale are that one is a concept in the short term, while the other can only occur in the long term.

A firm can use both to increase output, and both can lead to unwanted negative effects, if taken too far. However, a firm can maximise its profits after the marginal product of the variable factor has started to fall, as long as employing the additional factor of production adds more to the firms' total revenue than it does to costs.

If a firm is experiencing decreasing returns to scale, on the other hand, it is no longer maximising profits. Diminishing returns which is also called diminishing marginal returns refers to a decrease in the per unit production output as a result of one factor of production being increased while the other factors of production are left constant.

According to the law of diminishing returns, increasing the input of one factor of production, and keeping other factor of production constant can result in lower output per unit.

This may seem strange as, in common understanding, it is expected that the output will increase when inputs are increased. The following example offers a good understanding of how this may occur. Cars are manufactured in a large production facility, where one car requires 3 workers in order to assemble parts quickly and efficiently. Currently, the plant is understaffed and can only allocate 2 workers per car; this increases production time and results in inefficiencies.

In a few weeks as more staff are hired, the plant now is able to allocate 3 workers per car, removing inefficiencies.

In 6 months, the plant is overstaffed and, therefore, instead of the required 3 workers, 10 workers are now allocated for one car.

As you can imagine, these 10 workers keep bumping into one another, quarrelling and making mistakes.