Returns to scale refer to the resulting change in output on account of an increase in the scale of operations, arising from the increased use of all factors required for its production. ‘Returns to Scale’ is therefore, different from returns to variable factor.
There can be constant, increasing or decreasing returns to scale.
(A) Increasing Returns to Scale:
Increasing returns to scale arises when output increases in a greater proportion compared to the increase in the inputs. If inputs are doubled and output becomes more than doubled, we have increasing returns to scale.
Let us explain this phenomenon with the following example,
Here, 2 labour and 3 units of capital produce 200 kg of paddy. If we double input (4L + 6K), the output will be more than doubled i.e., 500 kg of paddy. It is the case of increasing returns to scale.
Returns to scale increase because of the indivisibility of the factors of production. Indivisibility means that machines, management, labour and the like cannot be available in small sizes.
Modern writers consider that returns to scale increases on account of increasing opportunity for specialization of labour and economics of scale.
As the firm expands in size, there is scope for reaping the internal economies of production. Internal economies may be defined as those advantages which results from an increase in scale of production of firm.
Another important cause of increasing returns to scale lies in dimensional relations which have been emphasized by Professor Baumal. A wooden box of 3 foot-cube contains 9 times greater wood than the wooden box of 1 foot cube, that is 3 foot wooden box contains 9 times greater inputs.
But the capacity of the 3 foot-cube wooden box is 27 times greater than that of 1 foot cube. Similarly if the diameter of a pipe is doubled, the flow through it is more than doubled. This is also happens in case of production.
(B) Diminishing Returns to Scale:
When the output increases in a smaller proportion compared to increase in all inputs, there is said to be diminishing returns to scale. In this case, a given percentage increases in all the factors will be followed by a less than proportionate increase in output. In other words, if input is doubled and output would be less than doubled, it would be the case of diminishing returns in production.
Let us take an example to this phenomenon.
Here, 2 units of labour and 3 units capital produce 200 kg of paddy. If we double input (4L + 6K), the output will be less than doubled and becomes 300 kg only. This is the case of diminishing returns to scale.
Diminishing returns to scale arise on account of diseconomies arising from problems and difficulties of large scale management.
Another factor working in the same direction is the technical diseconomies which appear when production is extended beyond the optimum point.
(C) Constant Returns to Scale:
If returns increase in the same proportion as the increase in inputs, there is said to be constant returns to scale. If we double the inputs and output become equal to doubled, it will be said to be constant returns to scale. The following example makes it clear.
Here, 2 units of labour and 3 units of capital produced 200 kg of paddy. If we double inputs (4L + 6K), the output will be exactly doubled (400 kg). So, this is the case of constant returns to scale.
Some economists are of view that constant returns to scale will normally result if all factors of production become perfectly divisible Mrs. Joan Robinson, Nicholas Kaldor and F. H. Knight point out that constant returns to scale is not seen in the case of some industries because it is not possible to increase or decrease all inputs in the same proportion.