10.Returns to Scale A company faces the following costs in addition to fixed costs of $50,000. How would you describe the returns to scale for this company looking only at the quantities below? Quantity Marginal Cost Sale Price Marginal Return 1 10,000 20,000 10,000 11,000 20,000 9,000 12,000 20,000 8,000 4 13,000 20,000 7,000 When you are looking to determine whether or not there are increasing or decreasing returns to scale you need to look at the average cost. If average cost is falling, you are experiencing increasing returns to scale (or economies of scale). If average cost is rising you are experiencing decreasing returns to scale (or diseconomies of scale). The marginal return is not relevant to this analysis and the movement of marginal cost is not an indicator of the returns to scale. The biggest other piece of this problem is recognizing that the marginal cost listed in the table is representing the cost of each additional unit! Therefore, the cost of unit 1 is 10,000, and the cost of unit 2 is 11,000, etc. So the cost of unit 1 & 2 will be 21,000 (10000 + 11000), etc. In addition, when calculating the average cost, you need to include the $50,000 fixed cost value. So when we look at it, we can see that the average cost is falling so there are increasing returns to scale. Quantity Marginal Cost Fixed Cost Total Cost Average Cost 1 10,000 50,000 60.000 60.000 2 11,000 50,000 71,000 35,500 09 12,000 50,000 83.000 27666.66667 4 13,000 50.000 96,000 24,000