Microeconomics



Microeconomics

Question 1

The law of diminishing marginal returns stats that when a firm introduces more variable inputs successively with one fixed factor of production, total returns would continuously increase, but marginal returns would diminish (Anderton, 1993). This can be explained with the help of graph given below.

`

It can be seen from the graph that when the firm was initially increasing the number of workers, total output was increasing at a greater rate every time; this is not because every new worker is more productive but merely because of the combined effect (Colander, 2007).

It can also be seen that total output is ultimately increasing at a decreasing rate. This basically is occurring because the proportion of inputs is continuously varying. The firm is facing scarcity of resources of capital (Lipsey, 2002). The ratio between capital and labour is continuously widening, which means that after a certain time, the capital is not enough for the increased workers, hence the returns started to diminish.

Since this situation would always be faced by every firm in the short run. That is why this fact is known as the law of variable proportions or diminishing returns.E.g. if the firm is facing shortage of capital, then increasing the number of labourers would benefit it to the extent whereby it can make 6 workers work at a machine at a time, rather than two. However when all the machines would be fully employed along with their operators, than the hiring up of new workers would only lead to increased costs, but no increased output or productivity.

In short, a firm faces diminishing returns when it increases its factor inputs with one factor fixed (i.e. the short run) and hence suffers diminishing productivities (Lipsey, 2002).

On the other hand, economies of scales are those cost saving advantages which occur when a firm increases its scale of production (Boyes, 2008). This might be inform of purchasing/bulk buying economies, technical economies, marketing, managerial, financial and risk bearing economies.

The decreasing economies of scale are the phenomenon which applies to the long run production of a firm. In fact this phenomenon even includes the theory of Diminishing Marginal Returns. It so happens that when the firm adopts an ever increasing production status (in the long run) its cost saving advantages tend to be more and more less (Lipsey, 2002). E.g. Bulk buying discounts may reach at a certain limit and then no longer discounts be offered. Similarly fixed costs might be at first spread at a higher proportion that this proportion might decline with time, since the addition of more units would tend to contribute lesser in bearing up fixed costs. The economies of scale which would have been showing increasing returns to scale would then start to show diminishing returns to scale. This is also known as Diseconomies of Scale (Anderton, 1993).

When the size of the organization becomes too big, the actual owner cannot control everything directly due to which de centralization occurs. Organization structure widens horizontally and vertically. Chain of command becomes too long ...