Diminishing marginal returns are an effect of increasing input in the short run while at least one production variable is kept constant, such as labor or capital. Returns to scale are an effect of increasing input in all variables of production in the long run.
Diminishing Marginal Returns
The law of diminishing marginal returns states with every additional unit in one factor of production, while at least one factor is held constant, the incremental output per unit decreases. Reducing the impact of this law may require discovering the underlying causes of production decreases. Businesses should carefully examine the production supply chain for instances of redundancy or production activities interfering with each other.
For example, a firm hiring more employees while keeping the same office space can increase total output, but every additional employee produces less additional output than the one before him. The total output can decrease at some point, resulting in negative returns if, for instance, the same firm hires too many employees who get in each other's way and eventually become unproductive.
Reversing this law, if production units are removed, the impact on production is minimal for the first few units and may realize substantial cost savings.
Returns to Scale
On the other hand, returns to scale refers to the proportion between the increase in total input and the resulting increase in output. Decreasing returns to scale is a condition when all production variables are increased by a certain percentage resulting in a less-than-proportional increase in output.
For example, if a soap manufacturer doubles its total input but gets only a 60% increase in total output, then it can be said to have experienced decreasing returns to scale. If the same manufacturer ends up doubling its total output, then it has achieved constant returns to scale, where the increase in output is proportional to the increase in production input. Increasing returns to scale, meanwhile, occurs when the percentage increase in output is higher than the percentage increase in input.