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OTHER THINGS EQUAL: A common assumption used in economic analysis that often goes by the technical Latin term, ceteris paribus. This assumption is used when identifying the relation between two specific variables, such as price and quantity for the law of demand. In so doing, the causal connection between the two variables can be identified. However, economic analysis becomes more interesting and useful when this assumption is relaxed, which makes it possible to examine how these "other things" affect the relation under study.
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                           RETURNS TO SCALE: Changes in production the occur when all resources are proportionately changed in the long run. Returns to scale come in three forms--increasing, decreasing, or constant based on whether the changes in production are proportionally more than, less than, or equal to the proportional changes in inputs. Returns to scale are the guiding principle for long-run production, playing a similar role that the law of diminishing marginal returns plays for short-run production. Returns to scale answer the question: If labor, capital, and other inputs ALL increase by the same proportion (say 10 percent) does output increase by more than, less than, or equal to this proportion (more than 10 percent, less than 10 percent, or exactly 10 percent)? The answer indicates that returns to scale can take one of three forms: increasing returns to scale, decreasing returns to scale, and constant returns to scale.- Increasing Returns to Scale: This occurs if a proportional increase in all inputs under the control of a firm results in a greater than proportional increase in production. In other words, a 10 percent increase in labor, capital, and other inputs, results in a production increase that is greater than 10 percent.
- Decreasing Returns to Scale: This occurs if a proportional increase in all inputs under the control of a firm results in a less than proportional increase in production. In other words, a 10 percent increase in labor, capital, and other inputs, results in a production increase that is less than 10 percent.
- Constant Returns to Scale: This occurs if a proportional increase in all inputs under the control of a firm results in an equal proportional increase in production. In other words, a 10 percent increase in labor, capital, and other inputs, results in an equal 10 percent increase in production.
Long-Run Stuffed Amigo ProductionSuppose, for example, that The Wacky Willy Company employs 1,000 workers in a 5,000 square foot factory to produce 1 million Stuffed Amigos (those cute and cuddly armadillos, tarantulas, and lizards) each month. Returns to scale indicate what happens to production if the scale of operation expands to 2,000 workers in a 10,000 square foot factory--a doubling of the inputs.If production increases to exactly 2 million Stuffed Amigos, twice the original quantity, then The Wacky Willy Company has constant returns to scale. If production increases by more than 2 million Stuffed Amigos, then The Wacky Willy Company has increasing returns to scale. And if production increases by less than 2 million Stuffed Amigos, then The Wacky Willy Company has decreasing returns to scale. Economies and Diseconomies of ScaleReturns to scale are the flip slide of economies of scale and diseconomies of scale. However, whereas economies and diseconomies of scale focus on cost, returns to scale focus on production.- Economies of scale indicate that long-run average cost decreases, which corresponds to increasing returns to scale in terms of production.
- Diseconomies of scale indicate that long-run average cost increases, which corresponds to decreasing returns to scale in terms of output.
- Constant returns to scale for production terms results when long-run average cost neither increases nor decreases.
The anticipated pattern for most production activities is that increasing returns to scale emerge for relatively small levels of production, which is then following be constant returns to scale and finally decreasing returns to scale. This pattern is represented by a U-shaped long-run average cost curve.NOT Marginal ReturnsDo not confuse increasing and decreasing returns to scale with increasing and decreasing marginal returns. While these phrases sound similar, they are quite different.Increasing and decreasing returns to scale relate to the long run in which all inputs under the control of the firm are variable. Increasing and decreasing marginal returns related to the short run in which one or more input is variable and one or more input is fixed. The existence of fixed inputs in the short run gives rise to increasing and decreasing marginal returns. In particular, decreasing marginal returns result because the capacity of the fixed input or inputs is being reached. However, in the long run, there are no fixed inputs, so no capacity constraint, so no marginal returns.
Recommended Citation:RETURNS TO SCALE, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2024. [Accessed: April 22, 2024].
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