Returns to scale: the change in percentage output resulting from a percentage change in all the factors of production. They are increasing, constant and diminishing returns to scale.

**RETURNS TO SCALE**

Returns
to scale: the change in percentage output resulting from a percentage change in
all the factors of production. They are increasing, constant and diminishing
returns to scale.

Increasing
returns to scale may arise: if the output of a firm increases more than in
proportionate to an increase in all inputs. For example the input factors are
increased by 50% but the output has doubled (100%).

Constant
returns to scale: when all inputs are increased by a certain percentage the
output increases by the same percentage. For example input factors are
increased by 50% then the output has also increased by 50 percentages. Let us
assume that a laptop consists of 50 components we call it as a set. In case the
firm purchases 100 sets they can assemble 100 laptops but it is not possible to
produce more than 100 units.

Diminishing
returns to scale: when output increases in a smaller proportion than the
increase in inputs it is known as diminishing return to scale. For example 50%
increment in input factors lead to only 20% increment in the output.

It is
classified into three stages; let us understand the stages in terms of returns
to scale.

**Stage I:**

The total
production increased at an increasing rate. We refer to this as increasing
stage where the total product, marginal product and average production are
increasing.

**Stage II:**

The total
production continues to increase but at a diminishing rate until it reaches the
next stage. Marginal product, average product are declining but are positive.
The total production is at the maximum level at the end of the second stage
with a zero marginal product.

**Stage III:**

In this
third stage total production declines and marginal product becomes negative.
And the average production also started decline. Which implies that the change
in input factors there is a decline in the over all production along with the
average and marginal. Our multiplier must always be positive, and greater than
1, since we want to look at what happens when we increase production.

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Engineering Economics and Financial Accounting : Production Function and Cost Anaysis : Returns to Scale |

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