Explain How a Firm Can Experience Diminishing Returns in the Short Run and Economies of Scale in the Long Run (15)

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A conventional business objective is to maximise profit where MC=MR. In order to do this, a firm has the option to expand to increase total output and therefore profit. This is shown in diagram 1. If a firm doesn’t expand then they will be stuck in the fixed plant period (where only labour can be added), which is point A on the diagram. Once the business begins to expand they will experience economies of scale but this is only in the very short run as the line of best fit along the diagram begins to plateau. Once the firm has begun to experience this, they become static and they cannot expand anymore if they want to keep ATC at the lowest possible point. If the firm continues to expand they move into the short run and experience the law of diminishing returns. This is due to the firm experiencing a divorce between ownership & control of the day-to-day running of the business. This is also called diseconomies of scale, where ATC increases as output rises. An example of diseconomies of scale in the real world would be General Motors. Before 2009 GM controlled 12 car companies worldwide and employed over 91,000 people. GM began a reorganisation of their company in 2009 and is predicted to be complete by 2014. The firm initially split due to declaring themselves bankrupt to the NYC Federal Bankruptcy Court on June 1st 2009 with debt of $172.81 billion, one of the largest corporate bankruptcies in US history. GM began to lose sales during the Automotive Industry Crisis of 2008-09 where posted their first loss. They decided to split and deconstruct their business in order to improve control and day-to-day running and decisions. They now control 8 car companies including Cadillac and Vauxhall and lost over 25,000 employees. They currently have positive revenues by over $150 billion and have experienced economies of scale in the long run. In diagram 2 it illustrates a shift

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