Reference no: EM133621200

Production Theory- Case Study

Returns to Scale in the Carpet Industry

The carpet industry in the United States centers around the town of Dalton in northern Georgia. From a relatively small industry with many small firms in the list half of the twentieth century, it grew rapidly and became a major industry with a large number of firms of all sizes. For example, the top five carpet manufacturers, ranked by shipments in millions of dollars in 2020, are shown in below Table. Currently, there are three relatively large manufacturers (Shaw, Mohawk, and Beaulieu), along with a number of smaller producers. There are also many retailers, wholesale distributors, buying groups, and national retail chains. The carpet industry has grown rapidly for several reasons. Consumer demand for wool, nylon, and polypropylene carpets in commercial and residential uses has skyrocketed. In addition, innovations such as the introduction of larger, faster, and more efficient carpet-tufting machines have reduced costs and greatly increased carpet production. Along with the increase in production, innovation and competition have worked together to reduce real carpet prices. To what extent, if any, can the growth of the carpet industry be explained by the presence of returns to scale? There have certainly been substantial improvements in the processing of key production inputs (such as stain-resistant yarn) and in the distribution of carpets to retailers and consumers. But what about the production of carpets?

Carpet production is capital intensive-manufacturing plants require heavy investments in high-speed tufting machines that turn various types of yarn into carpet, as well as machines that put the backings onto the carpets, cut the carpets into appropriate sizes, and package, label, and distribute them. Overall, physical capital (including plant and equipment) accounts for about 77 percent of a typical carpet manufacturer's costs, while labor accounts for the remaining 23 percent. Over time, the major carpet manufacturers have increased the scale of their operations by putting larger and more efficient tufting machines into larger plants. At the same time, the use of labor in these plants has also increased significantly. Carpet Sales, 2020 (Millions of Dollars per Year)

Carpet Sales, 2020 (Millions of Dollars per Year)

No.	Company	Millions of Dollar per year
1	Shaw	4346
2	Mohawk	3779
3	Beaulieu	1115
4	Interface	421
5	Royalty	298

The result? Proportional increases in inputs have resulted in a more than proportional increase in output for these larger plants. For example, a doubling of capital and labor inputs might lead to a 1 10-percent increase in output. This pattern has not, however, been uniform across the industry. Smaller carpet manufacturers have found that small changes in scale have little or no effect on output; i.e., small proportional increases in inputs have only increased output proportionally. We can therefore characterize the carpet industry as one in which there are constant returns to scale for relatively small plants but increasing returns to scale for larger plants. These increasing returns, however, are limited, and we can expect that if plant size were increased further, there would eventually be decreasing returns to scale.

Question: What is your conclusion from the above case? State your answers clearly.