Question

What is the difference between decreasing returns to scale and diminishing marginal product? [5 pts.]

Answer 1

Decreasing returns to scale and diminishing marginal product are very important concepts in micro economics. Let me explain these concepts in detail.

Decreasing returns to scale: When there is an increase in all the inputs, this increase will lead to increase in output, but less than the proportional increase in inputs. For example, a bikes manufacturing company increases all the inputs (labor , capital and raw materials) by 50%, then that will result in increase in output. But the increase in output will be less than 50%, say 40%. This is called decreasing returns to scale.

Diminishing marginal product: When there is an increase in the input(labor), keeping other inputs(example, capital) stable, this increase in labor will lead to increase in output, but less than the proportional increase in input (labor). For example, when the producer increases the labor from 100 to 150 , then the output will increase from 1000 units to 1200 units only. It will not increase in proportional to increase in the input (labor). Here there is 50% increase in labor, but the increase in output is only 20%. This is called diminishing marginal product. This simply means that increasing the labor for increasing output is less productive.

Diminishing marginal product is different from decreasing returns to scale. In case of decreasing returns to scale, we are looking at the effect on output by changing all the inputs. Whereas in case of diminishing marginal returns we are looking at the effect on output by changing one input(example labor), keeping all other inputs constant or stable.