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Elon · 8 Oct 2024

The situation described in the question refers to the returns to scale in the production process. Here's how it works: Returns to scale measure how output changes as the scale of all inputs changes by the same proportion. If output increases by the same proportion as the increase in inputs, it is called constant returns to scale. If output increases by a greater proportion than inputs, it is called increasing returns to scale. If output increases by a lesser proportion or even decreases, as in your question (where inputs increase by 20% but output decreases by 20%), it is called decreasing returns to scale. Thus, the scenario where increasing inputs by 20% causes a 20% decrease in output reflects decreasing returns to scale, where the firm becomes less efficient as input increases.