6.18 : Returns to Scale II

Returns to scale can also be decreasing or constant, in addition to increasing. A firm could experience decreasing returns to scale. This means that a proportionate increase in all inputs leads to a smaller proportional increase in output. For instance, doubling inputs might only increase output by 60%.

Reasons for decreasing returns to scale include:

1. Difficulty in monitoring large, geographically dispersed workforces

2. Challenges in replicating managerial talent and corporate culture at scale

3. Increased conflicts across inputs as operations grow, such as complications in maintaining timely communications up and down longer assembly lines or across larger warehouses.

These factors show that after a certain level of growth, firms might face decreasing returns to scale, meaning that increasing their size doesn't lead to an equal increase in output.

Constant returns to scale occur when a proportional increase in all inputs leads to the same proportional increase in output. This means that if a firm doubles its inputs, such as labor and capital, the output also doubles, indicating a one-to-one relationship between the scale of input increase and the resulting output increase.

Understanding these concepts helps explain why some industries have many smaller firms, while others can sustain larger enterprises.