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Returns to scale

The increases in output which result from increasing the scale of some production activity. Suppose that the quantities of all the inputs used in producing a given output of a good are increased by the same proportion, e.g. 50 per cent. Then if output increases by a greater proportion, e.g. 55 per cent, returns to scale are said to be increasing; if output increases in the same proportion (50 per cent), then returns to scale are said to be constant; and if output increases by a smaller proportion, e.g. 45 per cent, returns to scale are said to be decreasing. Thus, returns to scale refer to the way in which output changes when the whole scale of input changes. The nature of returns to scale will clearly influence the way in which costs of production vary with scale of output. lf returns to scale are increasing, then a given proportionate change in output requires a smaller proportionate change in quantities of inputs, and we would therefore expect costs to rise less than proportionately with output, implying a fall in cost per unit of output, i.e. a fall in average cost. Similarly, decreasing returns to scale imply increasing average costs. Since they relate to changes in all inputs, returns to scale are necessarily a long-run concept.

The usefulness of the concept of returns to scale lies in its role as a classifying device. It provides a convenient way of classifying particular types of technological condition. For a discussion of the reasons for increasing and decreasing returns to scale, see economies of scale and diseconomy. Note that returns to scale refer to the relationship between input and output, white economies of scale refer to the rela­tionship between cost and output, so that only those sources of economies and diseconomies of scale which are based on the input­output relationship are also sources of increasing and decreasing returns to scale respectively.

Reference: The Penguin Dictionary of Economics, 3rd edt.