Economics · Ch 3 — Production Analysis
Laws of Returns to Scale
Laws of Returns to Scale
While the Law of Variable Proportions applies to the SHORT RUN (one factor fixed, one varied), the Laws of Returns to Scale apply to the LONG RUN, where ALL factors are varied together, in the SAME proportion — this is what economists mean by a change in the "scale" of production. Three outcomes are possible when every input is increased in the same proportion:
The Three Laws of Returns to Scale
- Increasing Returns to Scale (IRS): output increases in a GREATER proportion than the increase in inputs (e.g. inputs double, output more than doubles).
- Constant Returns to Scale (CRS): output increases in EXACTLY the same proportion as the inputs (e.g. inputs double, output exactly doubles).
- Diminishing Returns to Scale (DRS): output increases in a SMALLER proportion than the increase in inputs (e.g. inputs double, output less than doubles).
For example, if a firm using 2 units of labour and 2 units of capital produces 10 units of output, and doubling both inputs to 4 units each raises output to 22 units, output has more than doubled (a 120% rise against a 100% rise in inputs) — Increasing Returns to Scale. If doubling the SAME inputs again, to 8 units each, raises output only to 40 units (an 82% rise against a 100% rise in inputs), the firm has moved into Diminishing Returns to Scale. It is entirely normal for a firm to pass through increasing, then constant, then diminishing returns to scale as it continues to expand — this progression is not a contradiction but the typical long-run experience of a growing firm. …