Diminishing Returns vs Decreasing Returns to Scale
Diminishing returns and decreasing returns to scale are terms widely used in the study of economics. They both show how levels of output can fall when inputs are increased beyond a certain point. Despite their similarities, diminishing returns and decreasing returns to scale are different to one another. The article provides a comprehensive explanation on each, highlights their similarities and differences, and improves understanding with extensive examples.
What is Diminishing Returns to Scale?
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. Since only one factor of production was increased (workers) this ultimately results in large costs and inefficiencies. Has all factors of production increased together, this problem would have most likely been avoided.
What is Decreasing Returns to Scale?
Returns to scale looks at how production output changes in response to an increase in all inputs by a constant rate. There are increasing returns to scale, constant returns to scale, and diminishing returns to scale. Decreasing returns to scale is when a proportionate increase in all inputs results in a less than proportionate increase in levels of output. In other words, if all inputs are increased by X, outputs will increase by less than X (a lower proportionate increase). As an example, a factory of 250 square feet and 500 workers can produce 100,000 tea cups a week. Decreasing returns to scale would occur if all inputs we increased (by a factor of 2) to 500 square feet and 1000 workers, but output will increase only up to 160,000 (less than a factor of 2).
What is the difference between Diminishing Returns and Decreasing Returns to Scale?
Diminishing returns and decreasing returns to scale are both terms closely related to one another. They both look at how increasing levels of inputs beyond a certain point can result in a fall in output. The main difference between the two is that for diminishing returns to scale only one input is increased while others are kept constant, and for decreasing returns to scale all inputs are increased at a constant level.
Summary:
• Diminishing returns and decreasing returns to scale are both terms closely related, and look at how increasing levels of inputs beyond a certain point can result in a fall in output
• According to the law of diminishing returns to scale, increasing the input of one factor of production, and keeping other factor of production constant can result in lower output per unit.
• Decreasing returns to scale is when a proportionate increase in all inputs results in a less than proportionate increase in levels of output.
• The main difference between diminishing returns and decreasing returns to scale is that, for diminishing returns, only one input is increased while others are kept constant and, for decreasing returns, all inputs are increased at a constant level.