Returns to Scale

Introduction In the long run production of a commodity can be varied by changing all inputs simultaneously and in the same proportion (including fixed inputs). Change in scale of production refers to a stage when all factor inputs are changed in the same proportion. The way total output changes due to change in scale of production in long-run is known as law of returns to scale. Returns to Scale is defined into three stages as Constant Returns to Scale, Increasing Returns to Scale and Decreasing Returns to Scale. Constant Returns to Scale occurs when increase in output is proportionately equal to increase in all inputs. Increasing Returns to Scale occurs when increase in output is proportionately greater than increase in all inputs. Decreasing Returns to Scale occurs when increase in output is proportionately smaller than increase in all inputs. Returns to scale are generally explained in terms of ‘economies’ and ‘diseconomies’ of scale. Economies of scale are classified into internal economies and external economies. Diseconomies of scale again are classified into two: internal diseconomies and external diseconomies. The causes of economies of scale which results in increasing returns to scale induce: Indivisibilities and greater specialization. The causes of constant returns to scale can be explained in terms of limits of economies of scale. The causes of decreasing returns to scale are explained in terms of Complexity of management, exhaustibility of natural resources, etc.

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