Question

Between "Diminishing Returns and the Production Function" and Economies of Scale and Long-Run Costs", Which two economics concepts of production theory can be used by business owners to decide on key issues affecting their firms? How these two concepts are related?

Answer 1

Production requires satisfying the wants by producing a certain output through a combination of various inputs. These resources or inputs may be by business owners in such combinations as suits their business requirements leading to realisation of quicker and efficient decision making process especially in cases of key organisational goals.

The concept of diminishing returns is especially important for business firms. According to the theory of diminishing returns, as more and more of a variable factor   , say labour, is added to a certain quantity of fixed factor , say land, the resulting output may appear to be more at first but will eventually decline. The causes of decline are varied –the output could diminish because of depreciation of machines, overload, monotony exhibited by workers leading to lower productivity and so on. This will cause a significant effect on the costs levels of the firms and may disturb the cost structure, perhaps even leading to higher costs. Successive cycles of diminishing output levels may need a revamp of the cost structure of the firm since it is a sign of diseconomies of scale—higher per unit costs of production.

Growth of firms leads to expansion of scale of production, it will necessarily bring about economies of scale or lower per unit costs. These advantages of low costs may in the long run prove to advantageous for the firm to survive in the market by virtue of low costs and high profits. However it should be borne in mind that cause could significantly rise because of diseconomies of scale especially due to external factors like taxes and so on.

The internal economies like technical, managerial , bulk buying and so on give an edge to then form over its rivals since these are exclusively for the firm. There are certain advantages which all the firms may enjoy due to external factors like subsidies, availability of cheap labor and so on these could benefit all the firms in the industry. The firms are more prone to consider such long run advantages and costs for their key business operations.