Page 119 - DECO405_MANAGERIAL_ECONOMICS

Managerial Economics

Notes If you look at Figure 7.5, to produce X units of output L units of labour and K units of capital are
required. By doubling the input, the output increases by less than twice its original level. For
example, if inputs are 2L and 2K, output level ‘a’ is reached, which lies below the one
showing 2X.
Figure 7.5: DRS Production Function

It is also necessary for students to know the causes for increasing and decreasing returns to
returns to scale.

Task Production managers of a company estimate that their production process
is currently characterised by the following short run production function:
2
Q = 72X + 15X – X 3
where Q = tonnes of boxes produced per production period and X = units of variable input
employed per production period.
Graphically illustrate the production function, indicating the following:
1. the range of increasing returns
2. the range of decreasing returns.

Notes Causes of Increasing and Decreasing Returns to Scale
Causes of Increasing Returns to Scale
Increasing returns to scale are due to technical and/or managerial indivisibilities. One of
the basic characteristics of advanced industrial technology is the existence of mass
production methods. Mass production methods (like the assembly line car industry) are
processes available only when the level of output is large. They are more efficient than the
best available processes for producing small levels of output. For example, increasing
returns of scale may happen because each worker has specialised in performing a simple
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