Diminishing Returns in the Short Run vs. Economices of Scale in the Long Run

Economies of scale: Large companies can produce products at a much lower cost than small ones because the cost per unit drops as the volume of output rises

Larger firms tend to have lower cost compared to smaller firms, due to the fact that they are able to gain from economies of scale, but it is possible for larger firms to experience diseconomies of scale. As firms increase their production scale they tend to lower their production cost and move to the long run, this can be represented using the diagram

They can only produce small batches. Scale economies have brought down the unit costs of production and have fed through to lower prices for consumers. Economies of scale are a key advantage for a business that is able to grow. Most firms find that, as their production output increases, they can achieve lower costs per unit. Economies of scale are the cost advantages that a business can exploit by expanding their scale of production. The effect of economies of scale is to reduce the average (unit) costs of production.

Refer to the diagram. If price is reduced from P1 to P2, total revenue will:

The firm's profit maximizing output is less than the output associated with minimum average cost. The firm’s demand curve is not flat but is downward sloping. Thus in the long-run the demand curve will be tangential to the long-run average cost curve at a point to the left of its minimum. The result is excess capacity.”

In the short run, at least one of the firm’s resources is fixed, usually the size of the firm. In the long run, all the resources are variable. That is, the quantities of all resources can change to alter the firm’s level of output, including the size of the firm.

3.The Third is that some enterprises expand production scale for the benefit of scale economy, the market equilibrium is broken, the products are overabundant, and enterprises start to resort to the price reduction.

However, it is wrong to assume that the main difference between small and large companies is how much money they have. Large and small companies play very different roles in the national economy and in the minds of investors. The very large companies really are different than their smaller brethren, and not just because they have more money.

The two conventional financial clarifications for the development of firms have been economies of scale and economies of degree. Economies of scale emerge when a firm brings down its every unit generation expenses of a specific item by creating in more prominent amount. Division of work through specialization is one reason every unit expenses diminish as generation increments. Adam Smith depicted in the eighteenth century how a pin plant can expand its yield essentially if every specialist over and over performs a particular undertaking in the creation prepare as opposed to having every laborer freely make complete pins without any preparation (Ayyagari,2011).

Economies of scale are the reduction in costs of productions caused by increasing the scale of the production facility and spreading fixed costs over a larger output. This means that as Qantas expands to global markets, they can possibly gain more revenue through services and this would generate lower average costs and the potential for higher profits.

In addition, existing companies benefit from economies of scale. Overall this threat is assessed at a medium level.

Diseconomies of scale are described as companies that have grown too much and this has driven up cost. This makes me think of my former employer Cleveland Clinic and their buying of every hospital in the Northeast Ohio region. They have even purchased a hospital in the city of Akron Ohio too. This purchase was approved last fall. Buying all these hospitals increases operating cost for the Clinic and considering the issues with healthcare funding this will be an issue.

The firm is better off by producing, and not shutting down. When the market price is higher than the minimum average value cost, minimum revenue and minimum cost should be compared to find out the optimal level of output.The entry and exit are the only long run adjustments to consider. The firms in this industry have identical cost curves. The industry is in a constant cost to the scales. In long run, if economic profits are earned, firms enter the industry, which increases the market supply, causing the product price to go down. Until zero economic profits are earned, then the supply will be steady. If losses are incurred in the short run, firms will leave the industry, which decreases the market supply, causing the product price to rise until losses disappear.

The production function of a firm relates the quantity of inputs to the quantity of outputs. For this analysis, Simple Simon’s production function is a linear function with labor as its only input. Production functions can be short run or long run. In the short run, capital inputs like plant and machinery are fixed and only variable inputs like labor and raw materials can be changed (Production Functions, p.1). Depending on what stage of production the firm is in, the law of diminishing returns affects the level of output. The law of diminishing returns states that as more units of a variable input (i.e. labor) are added to fixed amounts of land and capital, the change in total output will at first rise and then fall. Simple Simon is so under-utilizing its labor that even if the number of workers is doubled, there is still not a reduction in the level of output per unit of labor.

Increasing returns are the natural outcome of decreasing output costs and have external and internal factors which influence economies of scale (Ossa, n.d.). Economies of scale are influenced externally by industry size, rather than firm size and include