Question

In a production process is it possible to have decreasing marginal product in an input and yet increasing returns to scale?

Short answer

Yes, it's possible due to efficiencies when increasing all inputs together.

Step-by-step solution

Define Marginal Product

Marginal Product (MP) refers to the additional output generated by adding one more unit of input, while keeping other inputs constant. Decreasing marginal product occurs when each additional unit of input contributes less to the output than the previous unit.

Explain Returns to Scale

Returns to scale describe how output changes as all inputs are increased proportionally. Increasing returns to scale occur when the output increases by a greater proportion than the increase in inputs. For example, doubling all inputs results in more than double the output.

Illustrate How Both Can Occur Together

While decreasing marginal product focuses on the input-output relationship when changing a single input, increasing returns to scale consider all inputs together. It's possible that increasing all inputs proportionately creates efficiencies or economies of scale, such as better equipment or optimized use of resources, resulting in a higher output increase than expected. Nonetheless, focusing on a single input might show decreasing productivity due to factors like saturation or inefficiencies in its isolated usage.

Conclude the Possibility

Conclusively, yes, a firm can experience decreasing marginal product concerning one input due to its isolated inefficiencies, while still benefitting from increasing returns to scale by changing all inputs together, revealing efficiencies and synergies in combined operation.

Key concepts

Marginal Product

The marginal product measures how much additional product is generated with an additional unit of input. It's like checking the extra cookies you can bake by adding another cup of flour. But, sometimes adding more of the same ingredient doesn’t yield as many extra cookies. This is what we call decreasing marginal product. It happens when each extra input contributes less to the output than before. Imagine adding more cooks in a small kitchen—after a point, each one adds less value because they can get in one another’s way. This scenario highlights the decreasing productivity from one particular input while holding others constant.

Returns to Scale

Returns to scale tell us what happens when we increase all inputs proportionally. Think about scaling up a recipe. Increasing returns to scale means that when we increase all ingredients proportionally, our batch size grows more than we anticipated. This occurs because when you double everything, including oven space and mixing bowls, efficiencies emerge. You get more product from the new scale than if you made two smaller batches. It's important to note that "returns to scale" considers all inputs combined, unlike the focus on single inputs in assessing marginal product.

Economies of Scale

Economies of scale are the cost advantages a business gets as it increases production. When a company grows, it might buy materials in bulk at a discount or spread its fixed costs over more units. These give companies significant savings. Therefore, larger companies often have lower average costs per unit than smaller ones. This is often seen in industries with high initial set-up costs but lower costs per unit with increased volume. Economies of scale are a core reason why increasing returns to scale can take place, as efficiencies and cost benefits are realized when expanding output levels.

Input-Output Relationship

The input-output relationship is the foundational principle that describes how varying amounts of input translate into output. Imagine a car factory where different amounts of steel and labor produce cars. Understanding this relationship helps businesses determine optimal input levels for desired output. Sometimes, adding more of one input doesn’t necessarily lead to a proportionate output increase due to factors such as equipment limits or management capacity, highlighting decreasing marginal returns. Conversely, when all inputs are scaled up, firms can capture efficiencies that result in increasing returns to scale, showing the interconnectedness and balance needed between inputs to optimize production.