Returns to Scale

Returns to scale can be defined as, changes which arises in output resulting from a proportional change in all inputs. Returns to scale can be of three types –

1. Increasing Returns to Scale – It refers to a situation where output increases by more than that proportional changes in inputs. So if inputs are doubled then output will increase by more than double.

2. Constant Returns to Scale – It refers to a situation where output increases in the same proportion as that of input, so if inputs are doubled then output will also be doubled.

3. Deceasing Returns to Scale – It refers to a situation where output increases less than the increase in inputs, so if inputs are doubled than output will not rise in the same proportion as that of input.

Knowledge of returns to scale is essential for a company because a company will always like to produce those goods which give increasing returns to scale as it will be more profitable for a company to produce such goods, whereas it would want to avoid those products which give decreasing returns to scale because it will mean less profits for the company.

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