Absolutely one of my favorite (long run) micro topics because this concept is so relevant, not just in this course, but also in the real world!
Some terms to start off with .......
Economies of Scale = Increasing Returns to Scale
Diseconomies of Scale = Decreasing Returns to Scale
There's also Constant Returns to Scale --- a very important assumption in Economics, in general.
Something to note is that "The Law of Diminishing Marginal Returns" is a short run, not a long run concept, and doesn't apply to the topic of Economies/Diseconomies of Scale.
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Let's assume that a firm doubles its inputs. Instead of L = 1 and K = 1, let's suppose that L = 2 and K = 2. [Note that since all inputs are now "variable", this is a long run, not a short run, situation!]
When inputs (L and K) double, one of three things will potentially happen to output:
Output more than doubles (Q > 2) then AC will fall .... called Economies of Scale
Output less than doubles (Q < 2) then AC will rise ... called Diseconomies of Scale
Output exactly doubles (Q = 2) then AC is constant ... called Constant Returns to Scale
To confirm what happens to AC, first determine why TC rises when inputs double. Remember that AC = TC/Q.
Check the graph on page 107 of your text for a picture of what's explained above.
