Diminishing Returns in the Short Run vs. Economices of Scale in the Long Run

Diminishing Returns in the Short Run vs. Economices of Scale in the Long Run

Production is the transformation of inputs into outputs. For firms to

remain in business, they should avoid running into bankruptcy by

efficient allocation of resources. The desired result is that as

inputs are utilized, outputs will magnify by a greater percentage or

the average cost per output will diminish according to "the law of

diminishing returns" and "economies of scale" respectively.

According to the universal definition of "the law of diminishing

returns", "when one of the factors of production is held fixed in

supply, successive additions of the other factors will lead to an

increase in returns up to a point, but beyond this point returns will

diminish, holding technology constant." As for "economies of scale",

when a firm increase its output by employing more of all factors, its

scale of production is enlarged and its average cost drops. The main

distinction between these two principles is that "diminishing returns"

applies only in short run as short run refers to the period where

changes take place only in variable factors. While "economies of

scale" is applicable only in long run with changes in all factors.

Bear in mind, short run and long run are defined in terms of whether

there are fixed factors of production or not instead of time.

"Diminishing returns" focuses on marginal product rather than average

cost to calculate the point where productivity is most efficient. The

relationship between the variable input and the output is illustrated

below.

As variable inputs are further increased beyond the point of maximum

productivity, ou...

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...ocation restriction is also a

possible explanation for the demand of products in small firms. Large

firms may not be available in some places so due to urgent necessity,

people are forced to visit those small firms. All these prove that

there's still demand for products sold by small firms. Since they are

small scale in production, they require less profit to cover up

expenses and the cost of normal operation is also less expensive.

Therefore, with the existing market, they still manage to earn enough

profit to stay in business. Moreover, small firms have greater

potential flexibility and closeness to customers so they can adjust to

the wants of the customers and gain their trust. Given all the above

reasons, it totally convinces why small firms still manage to stay in

business despite the competition from large firms.