Returns to Scale in Economics: Definition & Examples

Returns to Scale in Economics: Definition & Examples
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  • 0:01 What Is Returns to Scale
  • 1:33 Example
  • 2:14 Constant Returns to Scale
  • 2:37 What Does It Mean?
  • 3:07 The Assumptions
  • 3:37 Lesson Summary
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Lesson Transcript
Instructor: Jennifer Francis

Jennifer has a Masters Degree in Business Administration and pursuing a Doctoral degree. She has 14 years of experience as a classroom teacher, and several years in both retail and manufacturing.

The aim of this lesson is to present ''returns to scale'' as it is used in an economic context. The lesson will provide a definition of key terms, as well as some cause and effect relationships.

What Is Returns to Scale?

The terms 'economies of scale' and 'returns to scale' are related, but they mean very different things in economics. While economies of scale refers to the cost savings that are realized from an increase in the volume of production, returns to scale is the variation or change in productivity that is the outcome from a proportionate increase of all the input.

An increasing returns to scale occurs when the output increases by a larger proportion than the increase in inputs during the production process. For example, if input is increased by 3 times, but output increases by 3.75 times, then the firm or economy has experienced an increasing returns to scale.

A decreasing returns to scale occurs when the proportion of output is less than the desired increased input during the production process. For example, if input is increased by 3 times, but output is reduced 2 times, the firm or economy has experienced decreasing returns to scale.

When increasing returns to scale occurs, it results in economies of scale. This is owing to the fact that efficiency increases when organizations progress from small-scale to large-scale production. A loss of efficiency in the production process, even when the production has been expanded, results in decreasing returns to scale. This may occur if the organization becomes too large to be operated as one single entity. In this case, there is no economy of scale.

Example

Barry's Barbershop was experiencing what it thought was overwhelming customer purchases. In one week the shop served 250 clients. To capitalize on this market, Barry hired 2 additional barbers, which gave him a total of 10 barbers. In this case the barbers were the input of resource, increased by 25%. As a result, the barbershop experienced average weekly sales of 320 for the next five weeks, an increase in output of 28%, increasing returns to scale. If instead the barbershop had made 225 sales after the increase in input, it would have experienced decreasing returns to scale.

Constant Returns to Scale

A constant returns to scale means that the proportionate increase in input is exactly equal to the increase in output. In Barry's case the 25% increase in input would result in a 25% increase output. So, with the additional 2 barbers, production would increase from 250 to 313 clients. The level of efficiency is maintained.

What Does It Mean?

The main aim of using returns to scale as an economic measure is to determine the level of efficiency. The organization's production is efficient if it is able to maintain its current level of output with fewer inputs or resources or when it is able to increase output with the same level of input. The reverse is true; the organization is inefficient if it is unable to maintain the current production level with fewer inputs or increase output with the same level of input.

The Assumptions

To utilize returns to scale as a measure of production efficiency, the following assumptions are made:

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