Returns to scale
what happens as the scale of production increases in the long run, when all input levels (e.g. physical capital usage) are variable (chosen by the firm)
In economics, the concept of returns to scale arises in the context of a firm's production function. It explains the long-run linkage of increase in output (production) relative to associated increases in the inputs (factors of production).
In the long run, all factors of production are variable and subject to change in response to a given increase in production scale. In other words, returns to scale analysis is a long-term theory because a company can only change the scale of production in the long run by changing factors of production, such as building new facilities, investing in new machinery, or improving technology.
There are three possible types of returns to scale:
If output increases by the same proportional change as all inputs change then there are constant returns to scale (CRS). For example, when inputs (labor and capital) increase by 100%, output increases by 100%.
If output increases by less than the proportional change in all inputs, there are decreasing returns to scale (DRS). For example, when inputs (labor and capital) increase by 100%, the increase in output is less than 100%. The main reason for the decreasing returns to scale is the increased management difficulties associated with the increased scale of production, the lack of coordination in all stages of production, and the resulting decrease in production efficiency.
If output increases by more than the proportional change in all inputs, there are increasing returns to scale (IRS).
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This entry incorporates text from “Returns to scale” on English Wikipedia. Contributors are listed in the page history. Text is available under the Creative Commons Attribution-ShareAlike 4.0 License. Selected authority identifiers and statements are retrieved from Wikidata under CC0; their references and qualifiers remain part of the verification path.