As stated by Kout­soyian­nis, the term “returns to scale” per­tains to alter­ations in out­put when all fac­tors undergo simul­ta­ne­ous pro­por­tional changes.

Accord­ing to Leib­haf­sky, “returns to scale” encom­passes the over­all out­put’s behav­ior as all inputs are adjusted simul­ta­ne­ously, rep­re­sent­ing a con­cept applic­a­ble in the long run.

Three types of Return to Scale

The three stages are explained below:

Increas­ing Returns to Scale or Dimin­ish­ing Costs

Increas­ing returns to scale, also known as dimin­ish­ing costs, occur when boost­ing all pro­duc­tion fac­tors results in a greater-than-pro­por­tional surge in out­put.

For instance, if inputs are dou­bled, the out­put grows more than twice as fast.

This phe­nom­e­non, influ­enced by fac­tors like divi­sion of labor and exter­nal economies of scale, can be visu­al­ized below.

Increasing returns to scale: returns curve R rising steeply as labour and capital go from Q to Q1, lifting output from P to P1

The X-axis (OX) denotes ampli­fied labour and cap­i­tal, while the Y-axis (OY) sig­ni­fies height­ened out­put. Upon ele­vat­ing labour and cap­i­tal from point Q to Q1, the out­put surges from point P to P1, sur­pass­ing the incre­ment in labour and cap­i­tal fac­tors.

Dimin­ish­ing Returns to Scale

Dimin­ish­ing returns to scale, or ris­ing costs, mate­ri­al­ize when a con­sis­tent increase in all pro­duc­tion fac­tors leads to a pro­por­tion­ally smaller expan­sion in out­put.

In essence, dou­bling inputs doesn’t lead to a dou­bling of out­put.

This trend arises due to inter­nal and exter­nal dis­ec­onomies out­weigh­ing economies.

Diminishing returns to scale: raising labour and capital from Q to Q1 lifts returns only from P to P1 along a flattening curve

The X-axis (OX) sym­bol­izes labour and cap­i­tal quan­ti­ties, while the Y-axis (OY) rep­re­sents out­put. As fac­tors of pro­duc­tion surge from point Q to Q1 (higher quan­tity), the cor­re­spond­ing out­put increase from point P to P1 is rel­a­tively smaller. The out­come is that the increase in fac­tors of pro­duc­tion is more sub­stan­tial com­pared to the incre­ment in pro­duc­tion, thus under­scor­ing the pres­ence of dimin­ish­ing returns to scale.

Con­stant Returns to Scale

Con­stant returns to scale, or con­stant costs, emerge when out­put scales up in direct pro­por­tion to the enlarge­ment of pro­duc­tion fac­tors.

This equi­lib­rium arises when economies of scale bal­ance out dis­ec­onomies, typ­i­cally occur­ring after a cer­tain pro­duc­tion thresh­old.

Constant returns to scale: straight line OR, where more units of labour and capital (Q to Q1) raise returns from P to P1

This graph­i­cal rep­re­sen­ta­tion depicts that an increase in labor and cap­i­tal cor­re­sponds pre­cisely to an equiv­a­lent increase in out­put, result­ing in con­stant returns to scale.