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CMA Foundation · Fundamentals of Business Economics and Management · Theory of Production

In the long run, a firm moves through a stage of increasing returns to scale, then constant returns, and finally decreasing returns as it expands. Which feature is most directly the reason for the final stage of decreasing returns?

Decreasing returns to scale mainly arise from managerial difficulties in co-ordination, supervision and control when a firm becomes very large. Division of labour, bulk buying and use of large indivisible machines are advantages that cause increasing returns in the earlier stage of expansion.

  1. AGreater scope for division of labour and specialisation
  2. BBulk purchase of raw materials at discounts
  3. CDifficulties of management, co-ordination and control in a very large firmCorrect
  4. DUse of large and indivisible machines at full capacity

Explanation

Decreasing returns to scale arise mainly from managerial diseconomies: as a firm becomes very large, co-ordination, supervision and decision-making become harder. The other options are sources of increasing returns, such as specialisation, buying economies and indivisibility of large machines.

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