Returns to scale or production function with all inputs variable

Long run decisions of production are influenced by a change in all factors of production or the scale of production. A change in scale refers to a simultaneous and proportional change in all inputs. Returns to scale measures the percentage change in output resulting from a percentage change in all inputs. There are three types of returns to scale:

If the output increases in the same proportion as the proportionate change in inputs we have constant returns to scale,

Increasing returns to scale arise when the output increases in greater proportion than a proportionate change in input, and

Decreasing returns to scale exist when output increases by smaller proportion than a proportionate change in inputs.

 For instance, inputs are doubled from 2L and 2K to 4L and 4K. The movement from A to B depicts constant returns to scale as output also doubles from 50Q to 100Q. An increase in output from 50Q to 300Q Shows increasing returns to scale. Movement from 50Q to 75Q is a case of decreasing returns to scale as output less than doubles.

A common example of constant returns to scale occurs when a firm's production process is replicated. For instance, a manufacturer of electrical components finds that he can double its output by replicating its current plant and labour force. That is, by building an identical plant beside the old one. Similarly, a chain of dry cleaners can increase its volume of service by increasing the number of outlets (with a decreasing number of workers per outlet). So long as, all necessary inputs are readily available, and the firm can increase output in proportion to inputs via replication, constant returns to scale will hold. Firms of all sizes will survive equally well in constant returns to scale. 

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