Example
When all inputs increase by a factor of 2, new values for output will be:
- Twice the previous output if there are constant returns to scale (CRS)
- Less than twice the previous output if there are decreasing returns to scale (DRS)
- More than twice the previous output if there are increasing returns to scale (IRS)
Assuming that the factor costs are constant (that is, that the firm is a perfect competitor in all input markets), a firm experiencing constant returns will have constant long-run average costs, a firm experiencing decreasing returns will have increasing long-run average costs, and a firm experiencing increasing returns will have decreasing long-run average costs. However, this relationship breaks down if the firm is not a perfect competitor in the input markets. For example, if there are increasing returns to scale in some range of output levels, but the firm is so big in one or more input markets that increasing its purchases of an input drives up the input's per-unit cost, then the firm could have diseconomies of scale in that range of output levels. Conversely, if the firm is able to get bulk discounts of an input, then it could have economies of scale in some range of output levels even if it has decreasing returns in production in that output range.
Read more about this topic: Returns To Scale
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