Decreasing Returns to Scale

9 Key excerpts on "Decreasing Returns to Scale"

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  Profitability, Mechanization and Economies of Scale

  • Dudley Jackson(Author)
  • 2018(Publication Date)
  • Routledge

    (Publisher)

  Thus, although the total requirement for each factor input increases as the scale of output increases, the ratio between the factor inputs does not change. In other words, the capital- intensity of production theoretically remains constant as the scale of annual output increases among plants, and full increasing returns to scale is a phenomenon which is, in theory, distinct from mechanization. However, we shall show in subsequent chapters that the two forces often accompany each other in a highly interdependent way and that this happens for strong and compelling economic reasons. In other words, while mechanization and economies of scale can, in terms of pure theory, be distinguished one from the other, in practice the two may be difficult to distinguish—for good reasons which we shall subsequently explain. 7.8 Minimum cost production under full increasing returns to scale We have shown that, under the condition of full increasing returns to scale, each unit factor input requirement (at the minimum cost position) decreases 198 Profitability, Mechanization and Economies of Scale as the scale of annual output increases. The proportionate decrease will be according to the elasticity (1 - a - b)/(a + b ). At constant factor prices, this equi-proportionate decrease in each unit factor input requirement (at the minimum cost position) means that the minimum unit labour and capital cost combined will decrease in the same proportion. This can be shown as follows. Let v* denote the minimum unit labour and capital cost combined. Then: The expression in brackets is a constant, and we may denote it as j. For the illustrative case we have been considering./ = ($2.40 x 0.07683527 + 0.2 x 0.30734108) = 0.245872864. Hence for this illustrative case: v* = 0.245872864 0-0166667 In the case of increasing returns to scale, the exponent on Q must be negative and so the minimum unit labour and capital cost combined decreases as the scale of annual output increases.

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  Managerial Economics

  Problem-Solving in a Digital World

  • Nick Wilkinson(Author)
  • 2022(Publication Date)
  • Cambridge University Press

    (Publisher)

  The resulting proportionate increase in output determines the physical returns to scale for the firm. Two K K Q 2 Q 1 Q 1 Q 2 L L Zero substitutability Perfect substitutability Figure 6.6 Extreme cases of input substitutability 6.5 The Long Run 295 points need to be explained before moving on to the description and measurement of returns to scale. 1. Proportionate increase in all the inputs – It is always assumed in referring to returns to scale that all inputs increase by the same proportion. This is not necessarily optimal for the firm in terms of economic efficiency. If inputs increase by different proportions we have to talk about returns to outlay (measured in money terms). 2. Physical returns to scale – Returns to scale can be described in physical terms or in money terms, as will become clear in the next chapter. The two meanings do not necessarily coincide; for example, it is possible for a firm to experience constant physical returns to scale yet have increasing returns to scale in money terms (better known as economies of scale). (a) Types of returns to scale Returns to scale, in physical or money terms, can be of three types. The following are the three types of physical returns. 1. Constant returns to scale (CRTS) – This refers to the situation in which an increase in inputs results in an exactly proportional increase in output. 2. Increasing returns to scale (IRTS) – This refers to the situation in which an increase in inputs results in a more than proportional increase in output. 3. Decreasing Returns to Scale (DRTS) – This refers to the situation in which an increase in inputs results in a less than proportional increase in output. The reasons for these different returns to scale will be considered in the next chapter, when they are compared with the monetary aspects of returns to scale. However, we can use Table 6.1 to examine these different possibilities from the standpoint of quantitative measurement.

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  Perfect Competition and the Transformation of Economics

  • Frank Machovec(Author)
  • 1995(Publication Date)
  • Taylor & Francis

    (Publisher)

  A review of Figures 2 and 3 will hopefully clarify the Marshallian perspective upon which we have been elabourating in this section. Economies of scale along the average cost curve (declining cost per unit) occur whenever a firm is expanding along the increasing returns portion of its production function. In Figure 9.1, for example, consider function f1, which is homothetic and quasiconcave. Along cross-section OC, it exhibits increasing returns to scale only from O to P, then decreasing returns from P onward. Returns to scale are constant at inflection point P, which lies on a locus of constant-returns points on the production surface, a portion of which, PN, is illustrated. This locus of constant-returns input combinations can be projected onto the (L, K) plane as isoquant Q2 in Figure 9.2, where the cost-minimizing combination of inputs will be 100 machines and 200 workers.

  Similarly, isoquant Q1 represents the locus of points whose height is 1000 output units, (GE in Figure 9.1), while Q3 represents 4000—all projected from production surface f1. Firms facing infinitely elastic demands will seek to acquire operating funds sufficient to purchase 100 machines and 200 workers, so as to capture all the economies of scale between zero units and 3000 units, where unit cost is momentarily minimized. Beyond Q2=3000 in Figure 9.2 (i.e., beyond point P on f1 in Figure 9.1), Decreasing Returns to Scale on the production surface will cause diseconomies along the average cost curve (i.e., rising unit cost for an output exceeding 3000). These diseconomies are reflected in Figure 9.2 as the disproportionately higher capital and labour outlays required to move north-eastward from P along ray OR. For example, input usage would have to rise 50 per cent to boost output 33 per cent (from 3000 at P to 4000 at T). Of course, we are assuming that input supplies are perfectly elastic, so ΔPL/ΔQ=PK/ΔQ=0. Also, if demand is insufficient to sell 3000 units, the firm will produce along the downward sloping portion of its average cost curve.

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  A Reconsideration of the Theory of Non-Linear Scale Effects

  The Sources of Varying Returns to, and Economies of, Scale

  • Richard G. Lipsey(Author)
  • 2018(Publication Date)
  • Cambridge University Press

    (Publisher)

  As we will see later in this Element, when authors discuss the sources of favourable scale effects, such as more efficient capital or greater division of labour, they disagree in almost all cases as to whether the source causes an IRTS or an EoS. This should not surprise us in the light of our arguments both that the standard definition of returns to scale is deficient and that production actually takes place in multiple stages. Indeed, it is not obvious that there is any gain in distinguishing between these two concepts. However, if we wish to do so, the following definitions may suffice: returns to scale occur when there is a change in a firm’ s unit cost of production that would have occurred if all input prices had remained constant, while economies or diseconomies of scale occur if there are changes in a firm’ s unit cost including those that would not have occurred if input prices had remained constant. Thus, returns to scale are located in the relation between a firm’ s inputs and its output and these give rise to economies of scale which can also arise from sources such as input price changes due to changes in market power or upstream scale effects. For the rest of this study we use the type-1 definition where each different technique of production has its own PF, each one of which may differ from the others in the nature of inputs and the marginal rates of substitution among them at various scales of output. Those who wish to continue with the type-2 PF definition can think of returns to scale when we speak of efficiencies of design as defined below. Further Problems with the PF We note in passing that there are other serious problems connected with both of the definitions of a PF. To see these, consider the concept of technical effi- ciency, an engineering concept.

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  Antonio Serra and the Economics of Good Government

  • Sophus Reinert, Rosario Patalano, Sophus Reinert, Rosario Patalano(Authors)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  However, the moves to build alternative theories based on the cumulative causations set in motion by increasing and diminishing returns are not widespread. 96 Regardless of what happens to economic theory, increasing and dimin- ishing returns are in real life going to play key roles in determining the wealth and poverty of nations. In which technological and economic contexts these two factors are going to develop is an open question. On the one hand, we find a tendency towards extreme cases of increasing returns where information technology has opened up for production and distribution at marginal costs, which are close to zero. This may result in the extreme concentration of wealth and power – economically and politically – especially as the climate for establishing a global anti- trust organization is extremely weak. 97 352 Erik S. Reinert On the other hand, 3D printing might become part of a process of “distributed manufacturing” which counteracts the traditional indus- trial paradigm based on economies of scale and cheap transport. Another term – coined by Harvard Law School Professor Yochai Benkler – is “commons-based peer production”, also called “social production”. These terms describe a new model of socioeconomic production in which the creative energy of large numbers of people is coordinated (usually with the aid of the Internet) into large projects without tradi- tional hierarchical organization. Wikipedia, Facebook, and YouTube are examples of such peer production, creating economies of scope (in a shared infrastructure) rather than economies of scale. So – in a some- what paradoxical way – the hugely increasing returns to scale in IT infra- structure seem to lead to huge potentials for decentralization and less reliance on increasing returns in the final stages of production.

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  Economics of Production and Marketing of Citrus

  • Bhat, Anil(Authors)
  • 2021(Publication Date)
  • Daya Publishing House

    (Publisher)

  Chapter 2 Economic Theories of Production Production refers to the economic process of converting of inputs into outputs. Production uses resources to create a good or service that is suitable for use, gift-giving in a gift economy, or exchange in a market economy. This can include manufacturing, storing, shipping, and packaging. Also level of output of a particular commodity depends upon the quantity of input used for its production. In other words production means transforming inputs land, labour, capital) into an output. 2.1. Theoretical Orientation 2.1.1. Laws of Production Theory of production is based on the following laws of production such as: “Law of Diminishing Returns/Law of Increasing Cost, Law of Increasing Returns/Law of Diminishing Cost and Law of Constant Returns/Law of Constant Cost“ 2.1.1.1. Law of Diminishing Returns/Law of Increasing Cost The law of diminishing returns (also called the Law of Increasing Costs) is an important law of micro economics. The law of diminishing returns states that: “If increasing amounts of a variable factor are applied to fixed quantity of other factors per unit of time, the increments in total output will first increase but beyond some point, it begins to decline ”. This ebook is exclusively for this university only. Cannot be resold/distributed. Richard A. Bilas describes the law of diminishing returns in the following words: “If the input of one resource to other resources are held constant, total product (output) will increase but beyond some point, the resulting output increases will become smaller and smaller ”. · (a) Operation of Law of Diminishing Returns The classical economists were of the opinion that the law of diminishing returns applies only to agriculture and to some extractive industries, such as mining, fisheries urban land, etc. The law was first stated by a Scottish farmer as such.

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  Microeconomics

  A Global Text

  • Judy Whitehead(Author)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  External economies and diseconomies are exogenous factors generally outside of the producer’s control, such as the cost of inputs. Economies and diseconomies of scale should also be distinguished from economies and diseconomies of scope although there are some interrelationships. Typically, economies of scale are considered to be related to the supply or production side while economies of scope are related to the demand or marketing side and particularly to the bundling of goods for sale. However, in some cases, the promotional or marketing activities are included in the consideration of economies of scale in production. These can be seen as part of the administrative or managerial techniques which are part of the production function. Typically, the economies or diseconomies of scale mirror the returns to scale of the production function, increasing, constant and decreasing in the traditional cost theory or constantly decreasing in the modern theory. Returns to scale are considered to be only the technical part of economies of scale. C H A P T E R 6 179 C H A P T E R 6 COSTS AND SCALE It should be noted, in passing, that the minimum point of the LAC at which the production function is often considered to switch from increasing to Decreasing Returns to Scale is not strictly technically correct. It can be contended that the point of inflexion that signals the turning point is at the minimum of the LMC curve and this is to the left of the minimum point of the LAC . 6.4.1 Classification of economies of scale Economies of scale may be separated into those related to production per se and those that come from the effect of the scale of production on the factors external to the firm that affect internal costs. This second type is sometimes not considered internal economies of scale as internal economies are expected to take place ceteris paribus .

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  Microeconomics

  A Global Text

  • Judy Whitehead(Author)
  • 2014(Publication Date)
  • Routledge

    (Publisher)

  As a corollary, it also suggests, however, that once a producer can attain the minimum optimum scale, producers operating at much larger scales would have little if any cost advantage. The signal to producers fearing competition in a newly opened market, for example, is to seek to identify the minimum optimal scale for their industry and attempt to reach this level of output in order to meet any competitive challenges. This assumes that the firms are all using the same technology (managerial, production, etc.) meaning that they are essentially using the same production function.

  6.4 Economies of Scale

  The concept of economies of scale is a long-run phenomenon. These economies of scale are internal to the firm and may arise from increasing the number of plants (plant replication) as well as from increasing plant size. They may also derive from expanding the plant with the same product or by diversifying into other products. Diseconomies of scale must be considered as well.

  Internal economies and diseconomies of scale should be distinguished from external economies and diseconomies. Whereas internal economies determine the shape of the long-run average cost curve, external economies cause shifts in the position of the long-run average cost curve. External economies and diseconomies are exogenous factors generally outside of the producer’s control, such as the cost of inputs.

  Economies and diseconomies of scale should also be distinguished from economies and diseconomies of scope although there are some interrelationships. Typically, economies of scale are considered to be related to the supply or production side while economies of scope are related to the demand or marketing side and particularly to the bundling of goods for sale. However, in some cases, the promotional or marketing activities are included in the consideration of economies of scale in production. These can be seen as part of the administrative or managerial techniques which are part of the production function.

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  Alternative Principles of Economics

  • Stanley Bober(Author)
  • 2016(Publication Date)
  • Routledge

    (Publisher)

  But in modern times the notion of diminishing returns was taken up in a micro setting, serving to underpin cost curves of the firm and the normally constructed production function. And while the latter is talked about in terms of an aggregate relationship between output per capita and capital per capita, it does rest on the individual firm’s presumed ability to vary one input while holding other inputs constant. But this was more than simply setting the mechanics of production; it brought forth an understanding of the distribution of output based on marginal productivity considerations. The idea of taking the law of diminishing returns as an operative relationship on the firm level led to an aggregate production function that was used to account for the distributive shares of wages and profits based on factor marginal productivity. In addition, going back to its micro application, the law of diminishing returns served to account for the rising supply price of a particular commodity.

  So the question before us is what are the assumptions or modifications that positioned the law in its micro stance, being a cause of variation in the relative price of individual commodities? It is important to reiterate that diminishing returns in its original usage was understood to affect not only rent but also the cost of production in terms of a total sector, that is, agriculture as a whole. Thus even in its relation to costs, the analysis dealt with output as a whole and not with the relation between cost and quantity produced of an individual producing unit.

  Yet in its modern role, diminishing returns is involved in the theory of competitive pricing through its impact on the firm’s supply curve construction. All that was necessary was to generalize the particular case of agricultural land to a situation where, in the production of a particular commodity, a firm employs a considerable portion, if not all, of a productive input, the amount of which is fixed or can be increased at considerable cost. Consider then that we are dealing with firm alpha; an increase in the demand for alpha commodities will necessitate a more intense use of that input, resulting in the diminishing returns outcome with increasing costs and the usual upward-sloping supply curve.

  But this image of a single firm or industry using all of an input factor that is unique only to its production is rather unreal or very particular. What is more to the point is to presume that other firms, say beta and gamma, also utilized this input in some proportion to their output. Now assuming full employment and the competitive model equilibrium, an increase in the demand for alpha output will reflect a reduction in the demand of, let us presume, both the output of beta and gamma. Thus some of this fixed input will be transferred from firms in general (beta and gamma) to the alpha firm. What happens to costs of production in alpha in response to an increase in production then depends on the magnitude of the transfer. Again, the general context is that if a firm or an industry employs only a small portion of the “constant” factor, it is more likely to meet an increase in its production by drawing “doses” of the constant factor from other industries than by intensifying its own use of it.

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