Returns to Scale

Three types of returns to scale#

There are three pos­si­bil­i­ties.

Increas­ing returns to scale (dimin­ish­ing costs)#

Increas­ing returns to scale, also called dimin­ish­ing costs, occur when increas­ing all the fac­tors of pro­duc­tion raises out­put by a greater pro­por­tion.

For instance, if all inputs are dou­bled, out­put more than dou­bles.

This comes from things like the divi­sion of labour and economies of scale, and is shown below.

The x-axis (OX) shows labour and cap­i­tal, and the y-axis (OY) shows out­put. When labour and cap­i­tal rise from Q to Q1, out­put rises from P to P1, a pro­por­tion­ately larger increase than in the inputs.

Dimin­ish­ing returns to scale (increas­ing costs)#

Dimin­ish­ing returns to scale, also called increas­ing costs, occur when increas­ing all the fac­tors of pro­duc­tion in the same pro­por­tion raises out­put by a smaller pro­por­tion.

In other words, dou­bling all inputs less than dou­bles out­put.

This hap­pens when inter­nal and exter­nal dis­ec­onomies out­weigh the economies of scale.

The x-axis (OX) shows the quan­ti­ties of labour and cap­i­tal, and the y-axis (OY) shows out­put. When inputs rise from Q to Q1, out­put rises only from P to P1, a pro­por­tion­ately smaller increase. Inputs have grown faster than out­put, which is what dimin­ish­ing returns to scale means.

Con­stant returns to scale (con­stant costs)#

Con­stant returns to scale, also called con­stant costs, occur when out­put increases in exactly the same pro­por­tion as the fac­tors of pro­duc­tion: dou­ble the inputs, and out­put dou­bles.

This hap­pens when economies and dis­ec­onomies of scale bal­ance each other, usu­ally beyond a cer­tain level of pro­duc­tion.

The straight line shows that a given pro­por­tion­ate increase in labour and cap­i­tal brings exactly the same pro­por­tion­ate increase in out­put.