Returns to scale

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Returns to scale

If we increase the quantity of all factors employed by the same proportional amount, output will increase. The question of interest is whether the resulting output will increase by the same proportion, more than proportionally, or less than proportionally.

In other words, when we double Returns to scale inputs, does output double, more than double or less than double? These three basic outcomes can be identified respectively as increasing returns to scale doubling inputs more than doubles outputconstant returns to scale doubling inputs doubles output and decreasing returns to scale doubling inputs less than doubles output.

Returns to Scale

The concept of returns to scale are as old as economics itself, although they remained anecdotal and were not carefully defined until perhaps Alfred Marshall Marshall used the concept of returns to scale to capture the idea that firms may alternatively face "economies of scale" i. As we are focusing on technical aspects of production, we shall postpone the latter for our discussion of the Marshallian firm.

The definition of the Returns to scale of returns in to scale in a technological sense was further discussed and clarified by Knut Wicksel l,P. Although any particular production function can exhibit increasing, constant or diminishing returns throughout, it used to be a common proposition that a single production function would have different returns to scale at different levels of output a proposition that can be traced back at least to Knut Wicksell Specifically, it was natural to assume that when a firm is producing at a very small scale, it often faces increasing returns because by increasing its size, it can make more efficient use of resources by division of labor and specialization of skills.

However, if a firm is already producing at a very large scale, it will face decreasing returns because it is already quite unwieldy for the entrepreneur to manage properly, thus any increase in size will probably make his job even more complicated.

The movement from increasing returns to scale to decreasing returns to scale as output increases is referred to by Frisch As all our inputs in this case, the only input, x increase, output y increases, but at different rates.

Heuristically, a function exhibits decreasing returns if every ray from the origin cuts the graph of the production function from below.

At the most naive level, we justify increasing returns to scale by appealing to some "division of labor" argument. A single man and a single machine may be able to produce a handful of cars a year, but we will have to have a very amply skilled worker and very flexible machine, able to singlehandedly build every component of a car.

Now, as Adam Smith famously documented, if we add more labor and more machines, each laborer and machine can specialize in a particular sub-task in the car production process, doing so with greater precision in less time so that more cars get built per year than before.

The ability to divide tasks, of course, is not available to the single man and single machine. Specialization reflects, then, the advantage of large scale production over small scale. The total output increases, of course, but so does the productivity of each man-and-machine since fifteen men-and-machines can divide tasks and specialize.

So increasing factors fifteen-fold, increases output more than fifteenfold. In effect, we have increasing returns to scale. We should note that by justifying increasing returns by specialization implies that increasing returns is necessarily associated with a change of method.

But this implies there are indivisibilities in production. In other words, the specialized tasks available at large scale are not available at the smaller scale; consequently, as the scale of production increases, these indivisibilities are overcome and thus methods not previously available become available.

Wicksell, ; F. Edgeworth; N. Kaldor; A. Lerner; cf.

Returns to scale

Nonetheless, we should note that there are direct examples of pure increasing returns to scale. If one adds sufficient steel to the cylinder to double its circumference, one will be more than doubling its volume. Thus, doubling inputs steel in pipeline more than doubles output flow of oil.

In this example, increasing returns does not involve changes in technique. However, these pure examples are rare and the rationale for increasing returns is usually given by specialization. Thus, we can say equivalently that increasing scale captures the idea that there is technical progress with increasing scale.Decreasing returns to scale implies that a + b 1.

Now, the marginal products of capital and labor are: Now, the marginal products of capital and labor are. 3. Diminishing Returns to Scale. Explanation.

In the long run, output can be increased by increasing all factors in the same proportion. Generally, laws of returns to scale refer to an increase in output due to increase in all factors in the same proportion.

Decreasing returns to scale implies that a + b 1.

Returns to scale

Now, the marginal products of capital and labor are: Now, the marginal products of capital and labor are. Decreasing returns to scale occur when a firm's output less than scales in comparison to its inputs.

For example, a firm exhibits decreasing returns to scale if its output less . Apr 15,  · This video introduces the concept of returns to scale and discusses the distinction between increasing returns to scale, decreasing returns to scale, and con.

Returns to scale: Returns to scale, in economics, the quantitative change in output of a firm or industry resulting from a proportionate increase in all inputs. If the quantity of output rises by a greater proportion—e.g., if output increases by times in response to a doubling of all inputs—the production.

Returns to scale - Wikipedia