Economies of Scale

INCREASING RETURNS TO SCALE/ECONOMIES OF SCALE

"Returns" refers to the production side of the phenomenon, while "economies" refers to the cost side. One looks at a "scalar increase in inputs"– that is, an increase in all inputs in the same proportion (percentage). So this is inherently a long-run question.

Increasing/decreasing returns to scale: Output increases more/less proportionally than the increase in inputs. For example, a doubling of all inputs results in a more-than-doubling of output would represent increasing returns to scale. Can you state the case of decreasing returns to scale?

Economies/diseconomies of scale: Unit cost decreases/increases as output expands from a scalar increase in inputs.

Returns to scale has its effect through the measure of productivity. If, for example, inputs have doubled but output more than doubles, then output per worker is higher. For the new range of production, unit costs are lower because there has been an across-the-board increase in productivity. So in that new, higher range of production, the short-run, U-shaped ATC curve is at a lower position (but farther over).

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This page was last updated on Friday, July 21, 2006.