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In economics, the concept of returns to scale arises in the context of a firm's production function. It explains the long-run linkage of increase in output (production) relative to associated increases in the inputs (factors of production).
In the long run, all factors of production are variable and subject to change in response to a given increase in production scale. In other words, returns to scale analysis is a long-term theory because a company can only change the scale of production in the long run by changing factors of production, such as building new facilities, investing in new machinery, or improving technology.
There are three possible types of returns to scale:
If output increases by the same proportional change as all inputs change then there are constant returns to scale (CRS). For example, when inputs (labor and capital) increase by 100%, output increases by 100%.
If output increases by less than the proportional change in all inputs, there are decreasing returns to scale (DRS). For example, when inputs (labor and capital) increase by 100%, the increase in output is less than 100%. The main reason for the decreasing returns to scale is the increased management difficulties associated with the increased scale of production, the lack of coordination in all stages of production, and the resulting decrease in production efficiency.
If output increases by more than the proportional change in all inputs, there are increasing returns to scale (IRS). For example, when inputs (labor and capital) increase by 100%, the increase in output is greater than 100%. The main reason for the increasing returns to scale is the increase in production efficiency due to the expansion of the firm's production scale.
A firm's production function could exhibit different types of returns to scale in different ranges of output. Typically, there could be increasing returns at relatively low output levels, decreasing returns at relatively high output levels, and constant returns at some range of output levels between those extremes.[1]
In mainstream microeconomics, the returns to scale faced by a firm are purely technologically imposed and are not influenced by economic decisions or by market conditions (i.e., conclusions about returns to scale are derived from the specific mathematical structure of the production function in isolation). As production scales up, companies can use more advanced and sophisticated technologies, resulting in more streamlined and specialised production within the company.
^Den Hartigh, Erik, Fred Langerak (2001). "Managing increasing returns". European Management Journal. 19 (4): 370-378.
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cost Returnstoscale Pareto efficiency Self-organized criticality Submodular set function Sunk-cost fallacy Tendency of the rate of profit to fall Analysis...
L)/\partial L}}.} Returnstoscale can be Increasing returnstoscale: doubling all input usages more than doubles output. Decreasing returnstoscale: doubling...
constant economies of scale. For increasing returnstoscale the point of tangency between the LRAC and the SRAC would have to occur at a level of output...
economies of scale (i.e., is operating in a downward sloping region of the long-run average cost curve) if and only if it has increasing returnstoscale, the...
international trade theory which focuses on the role of increasing returnstoscale and network effects, which were originally developed in the late 1970s...
which the marginal cost first falls (increasing returnstoscale) and then rises (decreasing returnstoscale). In the simplest case, the total cost function...
{\displaystyle m>1} , the function exhibits increasing returnstoscale, and it exhibits decreasing returnstoscale if m < 1 {\displaystyle m<1} . If it is homogeneous...
can choose to utilise the information an isoquant gives on returnstoscale, by using it as insight how to allocate resources. Knowing how to allocate resources...
ideas among firms to achieve what economists call increasing returnstoscale. Increasing returnstoscale are internal economies of scale for a firm, and...
non-convex sets, when Piero Sraffa wrote about firms with increasing returnstoscale in 1926, after which Hotelling wrote about marginal cost pricing in 1938...
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earned per unit of input (unless there are increasing returnstoscale). In fact, it is likely to mean lower average wages and lower rates of profit. But...
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