4.1.4.1 THE LAW OF DIMINISHING RETURNS AND RETURNS TO SCALE

Define micro short run

At least one factor of production is fixed

Define micro long run

Factors are variable

Define micro very long run

Technology and automation

Define macro short run

Price level is sticky (Keynes), productivity

Define macro long run

Both change

Introduction to new technology

Give examples of new technology (macro long run)

Delivery drones by Amazon

AI

Driverless cars

Define marginal returns of labor

The change in the quantity of total output resulting from the employment of one more worker, holding all the other factors or production fixed

Short run production with fixed capital

What happens to marginal returns of labor with the first 5 workers? (in the diagram below)

As the firm adds labor (5 to 6 workers) the law of marginal diminishing returns sets in (due to one factor of production being fixed, not due to motivation)

At the point of diminishing marginal returns of labor mean that an extra worker joining the workforce is any less motivated?

The impact of diminishing marginal returns does not mean that an extra worker joining the labor force is any less motivated or hardworking

• only due to a factor of production being fixed (eg. space/machinery)

Increasing marginal returns are more likely when what?

• the workforce is relatively small

• adding an extra worker will allow the team to be more efficient and organized

• the firm will benefit from specialization and division of labor

Define total returns

The whole output produced by all the factors of production, including labor, employed by a firm

Define average returns of labor

Total output divided by the total number of workers employed

What is an example to remember about the difference between marginal and average returns?

Heights in a class

Which is steeper? (marginal or average returns)

Marginal is twice as steep as average

What shapes are revenue/returns/utility curves?

N shaped

What shapes are cost curves?

U shaped

Draw 2 diagrams showing total returns and average returns

Define law of diminishing marginal returns

A short term law which states that as a variable factor of production is added to a fixed factor of producing both the marginal and eventually the average returns to the variable factor will begin to fall

Define returns to scale

The rate by which output changes if the scale of all factors or production is changed

Define increasing returns to scale

When the scale of all the factors of production employed increases, output increases at a faster rate

Define constant returns to scale

When the increase of all factors of production employed increases, output increases at the same rate

Define decreasing returns to scale

When the scale of all the factors of production employed increases, output increases at a slower rate

What is a quick way to remember: increasing, constant and decreasing returns to scale

Outputs and inputs

Increasing - larger proportion

Constant - same proportion

Decreasing - smaller proportion

What is the difference between returns to scale and economies of scale?

Return to scale = the rate by which output changes if the scale of the factors of production is changed

Economies of scale = the benefits of a business being large

What type of theory is returns to scale?

Long run production theory

What type of theory is economies of scale?

Long run cost theory

Increasing returns to scale, causes what to happen to long run average costs/economies of scale?

To fall

Explain why? (increasing returns to scale leads to a fall in long run average costs)

• spreading fixed costs

• specialization and division of labor

• bulk purchasing discounts

• technological and equipment efficiency

The effect of increasing returns