Returns To Scale:

The behaviour of output of a firm in the long run as its scale of operation (varying all inputs) is changed is called Returns to scale. In other words, returns to scale are the relationships between changes in scale and changes in output. When the scale of production is increased the resulting output displays three (3) stages of returns to scale: increasing returns to scale, constant returns to scale and decreasing returns to scale. These are depicted by the long-run production schedule below:

(a) Increasing Returns to Scale

Increasing returns to scale occur when increases in all inputs by a certain percentage cause a relatively higher percentage increase in output or total product. For instance in Table 5.2, when units of capital and labour were increased from 1 and 2 units to 2 and 4 units respectively (i.e. 100% increase in scale of production) output increased from 1000 to 2500 units (i.e. 150% increase in output).

(b) Constant Returns to Scale

When the scale production of the firm continues to grow, the greater percentage increase in total product ceases and instead a constant rate of growth in production is observed. Constant returns to scale occur when the scale of production is increased by a certain percentage, output or total product increases by the same percentage. For instance, in Table 5.2 as the capital- labour combination was doubled from 4 is to 8 to 8 is to 16 (100% increase in scale of production), output increased by the same 100%.

(c) Decreasing Returns to Scale

Finally, with further growth of the scale of the firm decreasing returns emerge. Decreasing returns to scale occur when the scale of production of a firm is increased by a certain percentage, output or total product increases by less than the given percentage. The total product indeed becomes larger but does so at a lower rate than the rate of growth of all the inputs used in production. For instance, from Table 5.2, a 100% rise in scale went with a lower than 100% rise in total product as when the inputs were increased from 8 and 16 units to 16 and 32 units.