Returns to Scale — The Long Run

In the long run there are no fixed factors — the firm can change the quantity of every input. Returns to scale studies how total output responds when all factors are increased together in the same proportion, so that the factor proportions stay unchanged and the scale of the whole operation changes.

This is the key contrast with the Law of Variable Proportions: there, one factor changed against a fixed factor, so the factor ratio changed; here, all factors change together, so the ratio is held constant and only the size of the plant changes.

The Three Kinds of Returns to Scale

Suppose all inputs are increased by, say, 100% (doubled). Output may respond in one of three ways:

Why Each Arises

• Increasing Returns to Scale appear first, mainly because of the economies of scale a larger operation unlocks: greater specialisation and division of labour, use of larger and more efficient indivisible machines, and technical/managerial economies that a small plant cannot capture.
• Constant Returns to Scale occur over a middle range, when the economies have been broadly exhausted and no serious diseconomies have yet set in — output simply scales up in step with inputs.
• Decreasing Returns to Scale set in eventually because of diseconomies of scale — chiefly the growing difficulty of managing, coordinating and controlling a very large organisation, so that output rises less than proportionately to inputs.

Returns to a Factor versus Returns to Scale — Do Not Confuse Them …