Returns to Scale

Refers to how output changes when the quantities of all inputs are changed.

Types

Constant Returns to Scale

Also known as CRS. Output increases in the same proportion as all inputs.

For example:

Increasing Returns to Scale

Also known as IRS. Output increases by a greater proportion than the increase in all inputs.

For example:

Decreasing Returns to Scale

Also known as DRS. Output increases by a smaller proportion than the increase in all inputs.

For example:

Diminishing Marginal Returns vs Returns to Scale

Diminishing Marginal Returns

• Short-run concept.
• At least one input is fixed.
• More of one variable input is added.
• Marginal product eventually decreases.

Returns to Scale Characteristics

• Long-run concept.
• All inputs are variable.
• All inputs are changed together.
• Measures the response of output to proportional changes in all inputs.

Economies and Diseconomies of Scale

Economies of scale are reductions in long-run average cost as output expands.

Sources:

• Optimum use of resources in the plant
• Inputs purchased in bulk
• Advertising cost spread over more units

Diseconomies of scale are increases in long-run average cost as output expands.

Sources:

• Coordination problems
• Weaker control
• Lower motivation in a very large firm

Worked Examples

Identifying a Diseconomy of Scale

Which of the following is a source of diseconomies of scale?

• Inefficiencies in the workforce
• Optimum use of resources in the plant
• Inputs purchased in bulk
• Reduced per-unit advertising cost