Law of diminishing marginal returns & economies of scale concept?

Question

How is the law of diminishing marginal returns similar and yet different from the economies of scale concept?

I for one dont see any similarity, can someone explain?

Answer 1

They both address the relation bettween the factors of production and output.

As production increases, the investment required for your fixed factor of production is diffused across a greater base. For example if you spend $100 million on a factory and produce 1 million units, your average fixed cost is $100 per unit. But if you produce 2 million units, your average fixed cost is $50 per unit. This is the essence of economies of scale. As production increases, the per unit cost decreases.

You also have variable factors of production (i.e. labor). When you hire the first person, s/he is super productive- lets say 10 units. The next person hired adds additional output, but only 6 units. The 3rd person hired adds more units of output, but only 1. This is the idea of diminishing marginal returns. Although your TOTAL return to a factor of production is increasing (one employee builds 10 things, two build 16 things, etc), the MARGINAL impact is decreasing. That is, the amount ADDED by the second unit is less than the first, the amount ADDED by the third is less than the second, etc.

Answer 2

Diminishing Marginal Return

Answer 3

The law of diminishing marginal return to input x states that you get less output the more you increase input x.

Increasing economies of scale is when you increase all inputs 5% you get more than 5% more output. There is constant returns to scale which says you get exactly 5% more output, and diminishing returns to scale, which says you get less than 5% output.

If you only have one input, then RTS and DMR are opposites.

If you have more than one input, then you can have diminishing marginal returns to scale for each input, but increasing returns to scale as a whole.

If you increase your inputs and your output more than increases then obviously your average cost is decreasing, as it is spread over larger amounts of goods. In constant returns to scale your average cost and marginal cost is flat.

Answer 4

the more you make something, the lower the unit cost (economy of scale). But at some point, the profit margin (returns) goes to zero. That's because you are lowering price by increasing supply.

See the connection?

Answer 5

The law of diminishing returns is similar to the economies of scale concept because both concepts are used to explain what happens when a company increases inputs to increase output. The two concepts are mutually exclusive (meaning that one or the other is at work, not both) but in a sense, they work together to explain the entire range of possible outcomes related to various levels of input.

Here's a VERY simplistic example that might make it clearer. Suppose I make paper airplanes in a rented garage. The fixed costs of the garage (rent, utilities, etc...) run $100 per month. Suppose I want to pay myself $1 per airplane and I buy a special paper for $1 per sheet. If I produce 100 units, my per unit cost is $3 ($1 for salary, $1 for materials, and $1 per unit for overhead). If I can up my production to 200 units, my per unit cost drops to $2.50...this is economies of scale.

Now take it a bit farther...I now have demand for 400 units so I hire someone else for $1 per plane and, because I buy a larger quantity of the paper, I can get it for $0.75 per sheet. Now my per unit costs drop to $2 per unit. Economies of scale are still working for me because of cheaper materials cost for buying in bulk and because I spread out my overhead across more units. Now I keep hiring people and buying more paper to produce planes in my rented garage. Eventually, we're going to start getting in each other's way in my tiny garage...this will increase errors (more waste) and I may hit the top of the maximum quantity discount for the materials. Now my per unit cost isn't getting lower as fast as it was...my returns are now diminishing. ...and when I eventually have to rent a larger garage, my per unit cost may actually increase because of the larger overhead.

Answer 6

Diagram of Economic of scale