4.1.4.3 Law of diminishing returns and returns to scale (AQA Economics)

This AQA Economics Study Note covers the law of diminishing returns (short run) and returns to scale (long run)

Understanding Production and Returns

1. Difference Between Short Run and Long Run:Short Run:

1. Definition:
   • Short Run refers to a period where at least one factor of production is fixed, and firms cannot adjust production capacity.
2. Example:
   • A bakery with a fixed-size oven is in the short run. It can hire more workers or adjust ingredients, but the oven capacity remains constant.

Long Run:

1. Definition:
   • Long Run is a period where all factors of production are variable, and firms can adjust production capacity.
2. Example:
   • If the bakery decides to build a larger facility or replace the existing oven with a bigger one, it operates in the long run.

Difference Between Marginal, Average, and Total Returns:

Marginal Returns:

1. Definition:
   • Marginal Returns indicate the additional output produced by employing one more unit of input while keeping other inputs constant.
2. Example:
   • If adding one more worker increases total output from 50 to 60 units, the marginal return of the additional worker is 10 units.

Average Returns:

1. Definition:
   • Average Returns represent the output per unit of input, calculated by dividing total output by the number of units of input.
2. Example:
   • If 3 workers produce a total of 150 units, the average return per worker is 50 units (150/3).

Total Returns:

1. Definition:
   • Total Returns are the overall output produced by a given combination of inputs.
2. Example:
   • 
     If a farm produces 1,000 bushels of wheat using a specific combination of labor and capital, the total returns are 1,000 bushels.

Law of Diminishing Returns:

Principle:

1. Statement:
   • The Law of Diminishing Returns asserts that as the use of one variable input increases while others are held constant, the additional output gained will eventually diminish.
2. Example:
   • In farming, as more fertilizer is added to a fixed amount of land, there is an initial increase in crop yield. However, beyond a certain point, additional fertilizer yields diminishing returns.

Returns to Scale:

Definition:

1. Returns to Scale refer to the change in output when all inputs are increased proportionately.

Difference Between Increasing, Constant, and Decreasing Returns to Scale:Increasing Returns to Scale:

1. Definition:
   • Increasing Returns to Scale occur when a proportional increase in all inputs leads to a more than proportional increase in output.
2. Example:
   • If doubling the inputs results in more than double the output, the firm experiences increasing returns to scale.

Constant Returns to Scale:

1. Definition:
   • Constant Returns to Scale occur when a proportional increase in inputs results in an equivalent increase in output.
2. Example:
   • If doubling the inputs leads to double the output, the firm experiences constant returns to scale.

Decreasing Returns to Scale:

1. Definition:
   • Decreasing Returns to Scale occur when a proportional increase in inputs leads to less than a proportional increase in output.
2. Example:
   • If doubling the inputs results in less than double the output, the firm experiences decreasing returns to scale.