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Decreasing Returns to Scale

Definition

Decreasing returns to scale occurs when an increase in all inputs used in production leads to a proportionately smaller increase in output. In other words, as the scale of production increases, the cost per unit of output increases.

Analogy

Imagine you have a pizza shop and you decide to double your ingredients (dough, sauce, toppings) while keeping everything else the same. However, due to limited oven space or lack of coordination among workers, doubling your ingredients doesn't result in exactly double the number of pizzas produced.

Related terms

Diseconomies of Scale: Diseconomies of scale refer to situations where increasing the scale of production leads to higher average costs per unit. This can occur due to factors such as coordination difficulties, communication problems, or inefficiencies in larger organizations.

Total Product: Total product represents the total output produced by a firm using different combinations of inputs. It helps measure the overall level of production achieved at various levels of input usage.

Fixed Costs: Fixed costs are expenses that do not change with the level of output produced. They include items like rent, insurance, and salaries that remain constant regardless of the scale of production.