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What is Diminishing Returns vs Economies of Scale about?

In the short-run (S-R), average costs have a U-shape due to diminishing returns. As more labor is added with capital held fixed, initially average costs fall due to increasing returns to scale, but eventually average costs rise as each additional worker contributes less to output. In the long-run (L-R), average costs also have a U-shape, but this is due to economies of scale as both capital and labor can vary, allowing firms to spread fixed costs over higher output levels up to an optimal size.

Author

Rafael Santos

Language

EN