Question

State the three kinds of returns to scale.

Explain returns to scale. 

Answer 1

In the short run, some factors are fixed and some are variable, so output changes with changes in factor proportions. But in the long run, all inputs can be changed since the firm has enough time. When all inputs are changed in the same proportion, it is called a change in the scale of production. The resulting change in output is explained by the law of returns to scale.

• Short run: Output changes due to change in factor proportion.
• Long run: Output changes due to a change in the scale of production.

Accordingly, the returns to scale could be ‘increasing’, ‘constant’ or ‘decreasing’. The three kinds of Returns to Scale are:

• Constant Returns to Scale: When inputs (like labour and capital) are increased in the same proportion, and output also increases in the same proportion. 
  

  Inputs (units)	Outputs (units)
  1 Capital + 1 Labour	100
  2 Capital + 2 Labour	200

  (Inputs doubled, output also doubled.)
• Increasing Returns to Scale: When inputs are increased by a certain proportion and the output increases by a greater proportion. 
  

  Inputs (units)	Outputs (units)
  1 Capital + 1 Labour	100
  2 Capital + 2 Labour	250

  (Inputs doubled, output increased more than double.)
• Decreasing Returns to Scale: When inputs are increased by a certain proportion and the output increases by a lesser proportion.
  

  Inputs (units)	Outputs (units)
  1 Capital + 1 Labour	100
  2 Capital + 2 Labour	150

  (Inputs doubled, output increased less than double.)