Today's task if to show your understanding of returns to scale and how it impacts output and costs.
Q1) Explain how returns to scale affects costs in the long-run
SCROLL DOWN FOR ANSWER
ANSWER:
Returns to scale describes the effect on output when a firm increases its factor inputs by a certain proportion. Increasing returns to scale, is when the firm gets proportionally more back in output after an increase in its inputs was made. For example, it could get back 150% in output back, when it increased its factor input volume by 100%. Decreasing returns to scale will be the opposite – the firm could increase its factor input by 100%, for example, but as a result the returns are less at 50%. Constant returns to scale occurs when the firm gets proportionally the same level of output back after an investment into factor inputs e.g. 100% return with a 100% increase in inputs.
As a business grows, in the early stages of its life it may find that it can achieve increasing returns to scale. As the business is getting proportionally more output back compared to its inputs, then the average cost of production is falling. This is because the firms’ costs are linked to how much it spends on its inputs. If inputs have risen by 100%, then it is likely that costs will have risen by around 100%. But the firm could be getting back 150% in output, so its long-run average costs should be decreasing and economies of scale should occur.
Towards the middle/end of the business’ life, it may start to experience decreasing returns to scale. So the business increases its factor inputs, but it could get back proportionally less. Due to the same logic as above, we should expect average costs to be increasing and therefore diseconomies of scale to occur.
We hope you enjoyed reading this content. Want to pass your Economics exams? Hire a specialist economics tutor today. At mrbanks.co.uk, we supply online Economics tuition to support you through your exams.
Online tuition provides so many benefits.
It’s cheaper. It’s less time-consuming. It’s effective.