Changes

As President of your company, think before you make long-run changes to increase output: do you have increasing, constant, or decreasing returns to scale?   

As President of your company, think before you make long-run changes to increase output: do you have increasing, constant, or decreasing returns to scale?   

===Diminishing Returns v. Returns to Scale

====Diminishing Returns v. Returns to Scale====

Do not confuse decreasing returns to scale with diminishing returns.  '''''Diminishing returns are something that occurs in the short run''''': it is the decline in marginal productivity as you keep increasing a variable input while all other inputs remain constant.  For example, asking one employee to work more and more overtime is going to have diminishing returns.  He is going to become so tired that he will not work as efficiently as when he is rested.  And even if he did not tire, the added benefit of the worker to your company by himself is going to decline without adding other workers or facilities to support him.  The entirely different concept of decreasing returns to scale refers to long term economic changes due to big modifications to your company.  Diminishing returns are always expected; decreasing returns to scale are not.

Do not confuse decreasing returns to scale with diminishing returns.  '''''Diminishing returns are something that occurs in the short run''''': it is the decline in marginal productivity as you keep increasing a variable input while all other inputs remain constant.  For example, asking one employee to work more and more overtime is going to have diminishing returns.  He is going to become so tired that he will not work as efficiently as when he is rested.  And even if he did not tire, the added benefit of the worker to your company by himself is going to decline without adding other workers or facilities to support him.  The entirely different concept of decreasing returns to scale refers to long term economic changes due to big modifications to your company.  Diminishing returns are always expected; decreasing returns to scale are not.

A typical firm can initially expect average unit costs to decline as it increases inputs (workers, facilities, etc.) from zero.  This is an increasing return to scale.  But at some point, call it when input = X, those increasing returns disappear and the company can only obtain constant returns to scale.  It has attained its “minimum efficient scale” at that point.  It can continue to increase its inputs, but its output only increases by the same amount as its input.  Ultimately, the company will find that increasing inputs further does not even increase output much.  It has too many workers or facilities at that point, and it begins to have decreasing returns to scale.

A typical firm can initially expect average unit costs to decline as it increases inputs (workers, facilities, etc.) from zero.  This is an increasing return to scale.  But at some point, call it when input = X, those increasing returns disappear and the company can only obtain constant returns to scale.  It has attained its “minimum efficient scale” at that point.  It can continue to increase its inputs, but its output only increases by the same amount as its input.  Ultimately, the company will find that increasing inputs further does not even increase output much.  It has too many workers or facilities at that point, and it begins to have decreasing returns to scale.

===Division of Labor===

====Division of Labor====

The key to increasing returns to scale, which is what every firm owner wants, is '''''division of labor'''''.  Train your employees to become specialists at certain functions so that they can be performed more efficiently.  Henry Ford was a master at this, training his workforce in a way that each employee was an expert at a particularized aspect of the assembly line.  The more specialized employees can become, the faster they can accomplish their task.  After a while, they could almost do their job in their sleep.  And that is a good thing, because doing the same task over and over puts one to sleep!   

The key to increasing returns to scale, which is what every firm owner wants, is '''''division of labor'''''.  Train your employees to become specialists at certain functions so that they can be performed more efficiently.  Henry Ford was a master at this, training his workforce in a way that each employee was an expert at a particularized aspect of the assembly line.  The more specialized employees can become, the faster they can accomplish their task.  After a while, they could almost do their job in their sleep.  And that is a good thing, because doing the same task over and over puts one to sleep!