Returns to Scale

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

There are three types:

1. Constant Returns to Scale
2. Increasing Returns to Scale
3. Decreasing Returns to Scale

Constant Returns to Scale

Output increases in the same proportion as all inputs.

For example:

Increasing Returns to Scale

Output increases by a greater proportion than the increase in all inputs.

For example:

Decreasing Returns to Scale

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