Distinguish between economies of scale and diminishing returns

Topics: Economics of production, Average cost, Costs Pages: 2 (714 words) Published: October 29, 2014

Distinguish between diminishing returns and economies of scale (15 marks)
In Business Economics, the short run is defined as the concept that within a certain period of time, in the future, at least one input is fixed while others are variable and the long run is defined as a period of time in which all factors of production and costs are variable. The law of diminishing returns is a short run concept, which states that increasing successive units of a variable factor to a fixed factor will increase output but eventually the addition to output will start to slow down and would eventually become negative. This is because if capital is fixed, extra labour will eventually get in each other’s way as they attempt to increase production. E.g. think about the effectiveness of extra employees in a factory that’s maximum workers is 100. If the firm employs 150 workers, then the productivity will eventually decrease, as they will get in each other’s way etc. However, this law only applies in the short-term, as in the long run, all factors are variable. 0343535Price

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As you can see from the graph above, the average fixed cost (AFC) curve falls as output increases due to the fact that fixed costs are a decreasing proportion of total cost as output increases. Both the average total cost (ATC) and the average variable cost (AVC) curves fall, and then rise again. The curves start to rise after a certain point because diminishing return takes place. The distance on the y-axis between the ATC and the AVC represents the value of the average fixed cost (AFC). Just like the average variable cost and average total cost curves demonstrate, the marginal cost also falls, and eventually rises again as diminishing marginal returns take place.

Economies of scale, however, refer to the advantages that arise from large-scale production, which in turn results in a lower average unit cost (cost per unit). It explains the relationship between the long run average costs...
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