The Law of Diminishing Returns and Returns to Scale

• Diminishing marginal returns occur when a firm increases its inputs of one factor of production while holding other inputs of the other factors of production fixed.
• Diminishing marginal returns happen in the short run, while returns to scale are a long run concept.
• Returns to scale refer to how output responds to changing inputs in the long run.
• Economies of scale occur when an increase in scale of production leads to a fall in long run average costs, while dis economies of scale occur when an increase in the scale of production leads to a rise in long run average costs.
• The minimum efficient scale of production is the point where long run average costs are minimized.

The law of diminishing returns states that if a firm increases its inputs of one factor of production while holding other inputs fixed, the additional output produced by adding more of the variable factor will start to decrease. This happens in the short run when at least one factor of production is fixed. In the long run, all factor inputs can be varied, and we see returns to scale, which are the change in output achieved by a firm as a result of a proportionate change in all inputs. There can be increasing, decreasing, or constant returns to scale, which affect the long run average cost curve. Economies of scale occur when an increase in scale of production leads to a fall in long run average costs, while diseconomies of scale occur when an increase in the scale of production leads to a rise in long run average costs. The minimum efficient scale of production is the point where long run average costs are minimized. The typical shape of the long run average cost curve is U-shaped, but it can also be L-shaped in industries where scale is crucial to production. Returns to scale and economies and diseconomies of scale are related but not the same thing.