Question

Explain why in the specic factors model production technologies have diminishing return to scale.

Answer 1

Answer: In economics, returns to scale and economies of scale are related but different concepts that describe what happens as the scale of production increases in the long run, when all input levels including physical capitalusage are variable (chosen by the firm). The concept of returns to scale arises in the context of a firm's production function. It explains the behavior of the rate of increase in output (production) relative to the associated increase in the inputs (the factors of production) in the long run. In the long run all factors of production are variable and subject to change due to a given increase in size (scale). While economies of scale show the effect of an increased output level on unit costs, returns to scale focus only on the relation between input and output quantities.

There are three possible types of returns to scale: increasing returns to scale, constant returns to scale, and diminishing (or decreasing) returns to scale. If output increases by the same proportional change as all inputs change then there are constant returns to scale(CRS). If output increases by less than that proportional change in all inputs, there are decreasing returns to scale (DRS). If output increases by more than the proportional change in all inputs, there are increasing returns to scale (IRS). A firm's production function could exhibit different types of returns to scale in different ranges of output. Typically, there could be increasing returns at relatively low output levels, decreasing returns at relatively high output levels, and constant returns at one output level between those ranges.[citation needed]

In mainstream microeconomics, the returns to scale faced by a firm are purely technologically imposed and are not influenced by economic decisions or by market conditions (i.e., conclusions about returns to scale are derived from the specific mathematical structure of the production function in isolation).