As a firm expands its output, after a certain point, it encounters growing diseconomies. These diseconomies, ultimately, more than cancel out the economies of large scale production and lower down the long run average production. The economies of production are swamped by diseconomies of production.
The main diseconomies are
- Managerial Diseconomies. These diseconomies occur primarily because of increasing managerial difficulties. As the output grows, top management becomes eventually overburdened and hence less efficient in its role as co-coordinator and ultimate decision-maker.
- Diseconomies due to exhaustible natural resources Another cause for diminishing returns to scale may be found in the exhaustible natural resources: doubling the fishing fleet not lead to a doubling of the catch of fish; or doubling the plant in meaning or on an oil-extraction field may not lead to a doubling of output.
As a result of these diseconomies of firm, long-run average and marginal cost rise with the increase in output and scale of production.
Thus, it is clear from our analysis that returns to scale have three forms increasing, constant and diminishing. The law of returns to scale with its all the three forms can be shown in one single example and diagram.
|Units scale of
|Return to Production scale
|1 Labor + 2 Ropani land
2 Labor + 4 Ropani land
3 Labor + 6 Ropani land
4 Labor + 8 Ropani land
5 Labor + 10 Ropani land
6 Labor + 12 Ropani land
7 Labor + 14 Ropani land
8 Labor + 16 Ropani land
From A to B in the diagram is the stage of increasing returns; from B to C constant returns, and from C to D is the diminishing returns to scale.
The main reason for the operation of the different forms of returns to scale is found in economics and diseconomies. When economies exceed the diseconomies, the stage of increasing returns operates; when economies and diseconomies equals each other, it becomes the stage of constant returns to scale; and when diseconomies exceeds the economies, then comes the stage of diminishing returns to scale.