Manual Increasing Return

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But some economic markets show increasing returns. If one company or product or technology gets advantage it gains further advantage—there are increasing returns or positive feedbacks. So when several such companies compete, one that by chance or clever strategy gets ahead may gain further advantage and can go on to dominate or lock in the market. But the one that wins need not be the best—it may have come to dominate partially by chance.

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Economics had long known about increasing returns but didn't know how to deal with them. Sometimes these small random events would steer the outcome into the dominance of firm X , other times into the dominance of firm Z.

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For example, if the factors of production are doubled then the output will also be doubled. The Law of Returns to Scale.

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  6. It is actually governed by three laws:. Increasing Returns to Scale.

    Diminishing Returns to Scale. Another common production function is the Cobb-Douglas production function. This describes a firm that requires the least total number of inputs when the combination of inputs is relatively equal.

    For example, the firm could produce 25 units of output by using 25 units of capital and 25 of labor, or it could produce the same 25 units of output with units of labor and only one unit of capital. Finally, the Leontief production function applies to situations in which inputs must be used in fixed proportions; starting from those proportions, if usage of one input is increased without another being increased, output will not change.

    For example, a firm with five employees will produce five units of output as long as it has at least five units of capital.

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    The law of diminishing returns states that adding more of one factor of production will at some point yield lower per-unit returns. In economics, diminishing returns also called diminishing marginal returns is the decrease in the marginal output of a production process as the amount of a single factor of production is increased, while the amounts of all other factors of production stay constant. The law of diminishing returns does not imply that adding more of a factor will decrease the total production, a condition known as negative returns, though in fact this is common.

    Diminishing Returns : As a factor of production F increases, the resulting gain in the volume of output V gets smaller and smaller. For example, the use of fertilizer improves crop production on farms and in gardens; but at some point, adding more and more fertilizer improves the yield less per unit of fertilizer, and excessive quantities can even reduce the yield.

    A common sort of example is adding more workers to a job, such as assembling a car on a factory floor. In all of these processes, producing one more unit of output will eventually cost increasingly more, due to inputs being used less and less effectively. This increase in the marginal cost of output as production increases can be graphed as the marginal cost curve, with quantity of output on the x axis and marginal cost on the y axis. For many firms, the marginal cost curve will initially be downward sloping, representing added efficiency as production increases.

    If the law of diminishing returns holds, however, the marginal cost curve will eventually slope upward and continue to rise, representing the higher and higher marginal costs associated with additional output.

    Comparing Diminishing Marginal Returns vs. Returns to Scale

    The average total cost of production is the total cost of producing all output divided by the number of units produced. Average total cost is interpreted as the the cost of a typical unit of production. Average total cost can also be graphed with quantity of output on the x axis and average cost on the y-axis. What will this average total cost curve look like?

    In the short run, a firm has a set amount of capital and can only increase or decrease production by hiring more or less labor.

    Returns to Scale: Meaning, Cobb Douglas Production Function, Examples

    The fixed costs of capital are high, but the variable costs of labor are low, so costs increase more slowly than output as production increases. As long as the marginal cost of production is lower than the average total cost of production, the average cost is decreasing. However, as marginal costs increase due to the law of diminishing returns, the marginal cost of production will eventually be higher than the average total cost and the average cost will begin to increase. Cost Curves in the Short Run : Both marginal cost and average cost are U-shaped due to first increasing, and then diminishing, returns.

    Average cost begins to increase where it intersects the marginal cost curve. The typical LRAC curve is also U-shaped but for different reasons: it reflects increasing returns to scale where negatively-sloped, constant returns to scale where horizontal, and decreasing returns due to increases in factor prices where positively sloped.