Returns to scale

 It refers to manner of change in output cost by
the increase in all the input simultaneously and in
the same proportion.
 Returns refers to “change in physical output”
 Scale refers to “quantity of input employed”
 Change in scale means that all factors of
production are increased or decreased in same
proportion.
2

 Returns to scale may be:
-increasing returns to scale
-constant returns to scale
-decreasing returns to scale
3

 When percentage (%) increase in all factor inputs
causes proportionately greater increase in output
it is (IRS)
 It is also known as stage of decreasing cost
 This stage occurs due to economies of large scale
production
 When a firm expands, increasing IRS obtained in
beginning
4

 If the amount of inputs are doubled and the
output increases by more than double, it is said to
be an increasing returns to scale.
 When there is an increase in the scale of
production, it leads to lower average cost per unit
produced as the firm enjoys economies of scale.
5

 More division of labor
 Use of specialized machines
6

 When percentage increase in all factor inputs
causes equal proportionate increase in output
 It is known as “linear homogeneous production
function”
 CRS operates when firm has achieved the point
of maximum capacity
 So this stage occurs due to combine effect of
economies and diseconomies of scale
7

 If a firm doubles inputs, it doubles output. In
case, it triples output. The constant scale of
production has no effect on average cost per unit
produced.
8

 When percentage increase in all factor inputs
causes proportionately less increase in output
 Generally there is a level after which output
increases in a smaller proportion as compare to
increase in the amount of factor inputs
9

 DRS occurs, if firm keeps on increasing the
inputs even after the stage of optimum capacity
 This stage also known as stage of increasing cost
and occurs because of economies of large scale
production
10

 If a firm increases inputs by 100% but the output
decreases by less than 100%, the firm is said to
exhibit decreasing returns to scale.
 In case of decreasing returns to scale, the firm
faces diseconomies of scale.
 The firm's scale of production leads to higher
average cost per unit produced
11

 Difficulty in coordination and management
 Technical diseconomies
 Limited availability of factors of production
12

 The figure shows that when a firm uses one unit of labour
and one unit of capital, point a, it produces 1 unit of
quantity as is shown on the q = 1 isoquant.
 When the firm doubles its outputs by using 2 units of
labour and 2 units of capital, it produces more than double
from q = 1 to q = 3.
 So the production function has increasing returns to scale
in this range. Another output from quantity 3 to quantity 6.
 At the last doubling point c to point d, the production
function has decreasing returns to scale.
 The doubling of output from 4 units of input, causes output
to increase from 6 to 8 units increases of two units only.
14

Returns to scale

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Returns to scale