Returns To Scale

Returns To Scale

Returns to Scale (Increasing and Decreasing), an economic law used to describe the relationship between the output of commodities and the scale of input of factors of production in the long run when the quantities of all the factors, used in unchanged proportions, are increased or reduced. This law is distinguished from the law of variable proportions or diminishing returns, which refers to the effect on output in the short run when the proportions of one factor relative to other (fixed) factors is changed.

At snail scales of production, the efficiency of a productive enterprise, measured as the output obtained per unit of factor employed, can often be increased by increasing its size. Conversely, increases In scale beyond a point may decrease productive efficiency. Increased efficiency, measured as increasing returns, may follow increases in scale because of the wider scope for specialization of labour and equipment. Workers can be concentrated on a narrower range of tasks or processes. Specialized equipment can be installed. Large-scale equipment, such as a canal or railway track, requires large scales of output lilt is to be used efficiently.

These ' economies of scale' arise from the indivisibility of the factors of production. Specialized equipment either cannot be reproduced at all in smaller sizes or can be reproduced only at higher cost per unit of output. Similarly the higher proficiency of workers specializing on a narrower range of processes cannot be reproduced if the degree of specialization is less. Management, marketing and finance are also subject to indivisibility: at a given point either they may be more efficiently employed at larger scales of output, or more specialized division of labour becomes possible.

These tendencies operate within limits. Beyond a point in the scale of output, indivisible equipment, earlier underemployed as measured by its optimum efficiency, may become over employed. Continued specialization of labour and equipment may produce problems of supervision and co-ordination. Increasing scale of management creates difficulties of control and rigidities. The scale of production at which 'diseconomies of scale' appear will vary from industry to Industry and often depends on the calibre of management. Eventually in all industries they will tend to outweigh the advantages of further specialization, and decreasing returns, that is, decreasing output per unit of input of the factors of production, will result.

The distinction between returns to scale and diminishing returns was not always made clear in the nineteenth-century economic literature. Increasing returns were thought to apply to manufacturing industry and diminishing returns to agricultural industry. It was seen later that both apply to all industries at different scales of operation. Another common error was the failure to distinguish between the increasing returns achieved by varying the amounts of the factors in a given state of technological knowledge and the 'historical' increasing returns produced during the nineteenth and twentieth centuries by invention and progress in technology, to which there would seem to be no limit.

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