Returns to Scale
Similar to economies of scale, but not quite.
Definition: 'Returns to scale occurs in the long-run period of a firm's production. The returns to scale is to with how output responds to a change in a firm's factor inputs.
Let's make this simple and do an example:
Imagine you double your factor inputs, labour and capital. So, before you employed 100 units of labour and 150 units of capital. Now, you employ 200 units of labour and 300 units of capital. What will happen to your total output?
See the tables below:
This table is an example of constant returns to scale. Labour and capital have increased by 100% and output has responded by also increasing by 100%.
This table is an example of increasing returns to scale. Labour and capital have increased by 100% and output has responded by increasing by 150%. The returns of output are greater than the increase in labour capital.
This table is an example of decreasing returns to scale. Labour and capital have increased by 100% but output has only responded by increasing by 50%. The returns of output are less than the increase in labour and capital.
How is this different to economies of scale?
It is different to economies of scale because economies of scale is all to do with long-run average costs. Returns to scale is all about factor inputs vs gains to output. So, returns to scale is a measure of output volume.
Now, there is a link between returns to scale and economies of scale. In fact, for economies of scale to occur, the firm needs increasing returns of scale to be happening. Why? Because if the firm can get more outputs for its inputs then it means the productivity of its inputs has increased, which brings down average costs.
What have we learned?
Definition of returns to scale. How it is only applicable in the long-run.
The link between economies of scale and returns to scale.
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