Increasing Return to Scale

Increasing Returns to scale refers to a situation where the total output increases in a greater proportion than the increase in units of factor inputs.

When the increase in output is more than proportionate to the given increase in the quantities of all factor-inputs, it is termed as increasing returns to scale.

For instance, if the increase in factor-inputs is 100 percent and the resultant increase in output is 150 percent, it is increasing returns to scale. We give an Illustration of increasing returns of increasing return to scale by a diagram. Form O three lines OS, OQ and OR are drawn cutting is the product curve 2, curve 3 at various points. Increasing returns to scale is shown as:

OR  > RP > PG

 

Or    OR1  > R1P1>  P1G1

 

Or    OR2 > R2P2 > P2G2

It means in this case, a doubling of inputs results in more than doubling of output. It is explained in the following example–

      Scale of Production          Total Output

(Machine + Labor)                 (Units)

1Machine + 2 Labor                     100

2Machine + 4 Labor                     250

Causes for the operation of increasing returns to scale

Why does increasing returns to scale operate? The reasons for the operation of increasing returns to scale are found in the form of economics of large-scale production. They are:

(i)      Labor Economies. They are also known as the economies the economies of specialization and division of labor. Division of labour and specialization are possible more in large-scale operation. Different types of works can specialize and do the job for which they are more suited. A worker acquires greater skill by devoting his attention to a particular job. Quality and speed of work both improve. This results in a sharp increase in output per man. Thus in short, with growing scale come, increasing specialization and increasing returns to scale.

(ii)     Technical economies. The main technical economies result from the indivisibilities that are characteristic of the modern industrial techniques of production. Several capital goods, because of the strength and weight required, will work only if they are of a certain minimum size. It may be technically possible to build smaller models of them; but it will not always be possible to use such models. Besides this, there is a general principle that as the size of a capital good is increased, its total output capacity increases far more rapidly than the cost of making it. To double the size and output capacity of a blast furnace for instance, we do not have to double the materials required. This is known as the principle of indivisibility

(iii)    Marketing Economies. Advertising space (in newspapers and magazines) and time (on television radio) and the number of salesmen do not have to rise proportionately with the sales. Thus the selling cost per unit of output falls with scale.

(iv)    Managerial Economies. Managerial economies arise from specialization of management and mechanization of managerial function. Large firms make possible the division of managerial tasks. This division of decision-making in large firms has been found very effective in the increase of the efficiency of management. Besides, large firms apply techniques of management involving a high degree of mechanization, such as telephones, telex machines, television screens and computers. These techniques save time and speed up the processing of information’s.

As the business firms continues to expand it gradually exhausts the economies, which cause the operation of, increasing returns to scale. Beyond this point, further increases in the scale of operation are accompanied by constant returns to scale.

(v)      Economies Related to Transport and Storage Costs. Because a large firm uses it’s own transport means and larger vehicles, per units transport costs would fall. Similarly, storage cost will also fall with the size.

As a result of all these economies firm’s long run average and marginal cost decline with the increase in output and scale of production.

6 thoughts on “Increasing Return to Scale”

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