Law of Diminishing Returns and Capacity Planning
Total output decisions of a firm depend on the demand made by the consumers. Production decisions in turn influence the selection of plant capacity in the short run. To operate in the second stage of increasing returns, the firm has to select the best combination of fixed inputs and variable inputs. That is, capacity planning should be done to use the resources rationally.
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Suppose the demand forecast for the firm is between 190 to 320 units, then the firm should build a plant with medium capacity as shown in Fig. 5.3. If the demand forecasts are greater than 320 units, then a plant with larger capacity should be planned and for demand less than 190 smaller capacity plant is optimal choice,
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