Returns to Scale

Returns to scale describes the rate of increase in production relative to the associated increase in the factors of production in the long run. At this point, all factors of production are variable (not fixed) and can scale. Therefore, the scale of production can be changed by changing the quantity of all factors of production.

The difference between economies of scale and returns to scale is that economies of scale show the effect of an increased output level on unit costs, while return to scale focus only on the relation between input and output quantities.

Returns to Scale

The Law of Returns to Scale

The laws of returns to scale are actually governed by three laws:

Law of Increasing Returns to Scale

If production increases by more than the proportional change in factors of production, there are increasing return to scale.

Law of Constant Returns to Scale

If production increases by that same proportional change as all factors of production change then there are a constant return to scale.

Law of Diminishing returns to Scale

If production increases by less than that proportional change in factors of production, there are decreasing return to scale.

Increasing Returns to Scale

Increasing returns to scale happens when all the factors of production are increased, then the output increases at a higher rate.

For example, if all inputs are doubled, then the output should increase at the faster rate than two times.

Diminishing Returns to Scale

Decreasing returns occurs when all the factors of production are increased in a given proportion, but the output increases at a smaller rate.

For example, if the factors of production are doubled, then the output will be less than doubled.

Constant Returns to Scale

Constant returns to scale occurs when the output increases exactly in the same proportion as the factors of production. For example, if the factors of production are doubled then the output will also be doubled.

You might also like