Decreasing Returns to Scale


Decreasing returns to scale are associated with problems of management of large, multi-unit firms. Again with think of a firm in which production takes place by a large number of units doing pretty much the same thing -- but the different units need to be coordinated by a central management. The management faces a trade-off. If they don't spend much on management, the coordination will be poor, leading to waste of resources, and higher cost. If they do spend a lot on management, that will raise costs in itself. The idea is that the bigger the output is, the more units there are, and the worse this trade-off becomes -- so the costs rise either way.

Decreasing Returns to Scale is also known as "diseconomies of scale" and as "increasing costs." All three phrases mean exactly the same.

 

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