Changes

But equally important are situations where there are “increasing returns to scale” (output goes up by a greater percentage than the increase in input) and “decreasing returns to scale” (output goes up by a smaller percentage than the increase in input).  '''''The popular term “economies of scale” refers to “increasing returns to scale,” which are what one often sees in a well-managed company.'''''

But equally important are situations where there are “increasing returns to scale” (output goes up by a greater percentage than the increase in input) and “decreasing returns to scale” (output goes up by a smaller percentage than the increase in input).  '''''The popular term “economies of scale” refers to “increasing returns to scale,” which are what one often sees in a well-managed company.'''''

Our example of the assembly line may yield slightly increasing returns to scale.  When we double the assembly line, we may not have to double the number of administrative workers like managers, clerks, phone operators, etc.  We won’t need two presidents, for example.  So we can double our output without doubling our workforce.  Perhaps we can even squeeze the second assembly line into our existing manufacturing plant.  We would still need twice the materials for the goods produced, but not twice the labor and facilities.  In this case we have increasing returns to scale: output doubles when inputs increased by less than 100%.

Our example of the assembly line may yield slightly increasing returns to scale.  When we double the assembly line, we may not have to double the number of administrative workers like managers, clerks, phone operators, etc.  We can double our output without doubling our workforce.  Perhaps we can even squeeze the second assembly line into our existing manufacturing plant.  We would still need twice the materials for the goods produced, but not twice the labor and facilities.  In this case we have increasing returns to scale: output doubles when inputs increased by less than 100%.

When would a firm have decreasing returns to scale?  How could it be that we can double our workers and facilities and not produce at least twice the output?  The reason is that inefficiencies creep in.  Workers may spend more time talking with each other than doing productive work.  Managers and other workers may fight each other for power rather than doing what is best for the company.  People may call in sick more often, knowing that others are there to fill in for them.  Waste could spiral out of control as more purchases are made.  Each employee will feel less needed, and may become less motivated.

When would a firm have decreasing returns to scale?  How could it be that we can double our workers and facilities and not produce at least twice the output?  The reason is that inefficiencies creep in.  Workers may spend more time talking with each other than doing productive work.  Managers and other workers may fight each other for power rather than doing what is best for the company.  People may call in sick more often, knowing that others are there to fill in for them.  Waste could spiral out of control as more purchases are made.  Each employee will feel less needed, and may become less motivated.