Three phases of returns to scale:The modifications in output as an outcome of changes in scale can be studied in 3 phases. They are:
Increasing returns to scale:
When the increase in all factors leads to a greater than proportionate augment in output, it is termed as increasing returns to scale. For illustration, when all the inputs are raised by 5 percent, the output rises by more than 5 percent that is, by 10%. In this situation the marginal product will be increasing.Constant returns to scale:
When we increase all the factors (that is, scale) in a specified proportion, the output will raise in similar proportion that is, a 5 percent increase in all the factors will outcome in an equivalent proportion of 5 percent raise in the output. Here the marginal product is steady.Decreasing returns to scale:
When the increase in every factor leads to a less than proportionate increase in output, it is termed as decreasing returns to scale that is, when all the factors are raised by 5 percent, the output will rise by less than 5 percent that is, by 3 percent. In this stage marginal product will be declining.
Table: Returns to scale
Figure: Returns to Scale
The figure above elucidates the different phases of returns to scale. Whenever marginal product increases (i.e., AB), net product rises at an increasing rate. Therefore there is increasing returns to scale. Whenever Marginal Product stays constant (i.e., BC), Total Product raises at a constant rate and this stage is termed as constant returns to scale. Whenever Marginal Product reduces (i.e., CMP), Total Product rises at a declining rate and it is termed as decreasing returns to scale.
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