Economies of scale and returns to scale are concepts closely related to one another and describe the effects that changes in production levels and costs will have, as inputs/outputs increase. These economies of scale and returns to scale are so similar to one another that they are mistakenly referred to as the same concept. This article provides a clear understanding of what economies of scale and returns to scale is and compares the similarities and differences between the two concepts.
What is Economies of Scale?
Economies of scale is a concept that is widely used in the study of economics and explains the reductions in cost that a firm experiences as the scale of operations increase. A company would have achieved economies of scale when the cost per unit reduces as a result of an expansion in the firm’s operations. Cost of production entails two types of costs; fixed costs and variable costs. Fixed costs remain the same, regardless of the number of units produced such as the cost of property or equipment. Variable costs are costs that change with the number of units produced, such as the cost of raw material and labor cost, given that salaries are paid at a per hour or per unit basis. The total cost of a product is made up of fixed and variable costs. A firm will achieve economies of scale when the total cost per unit reduces as more units are produced. This is because, even though the variable cost increases with each unit produced, the fixed cost per unit will reduce as the fixed costs are now divided among a larger number of total products.
What is Returns to Scale?
Returns to scale is a concept related to economies of scale and refers to changes that are made to a firm’s output depending on increases in the amount of inputs made. Returns to scale measures the rate at which the output increases when inputs are increased. Types of returns to scale include constant returns to scale, increasing returns to scale, and diminishing returns to scale. If the output increases by the same rate at which inputs are increased, that is called constant returns to scale. If the output increases at a higher rate than the rate at which inputs are increased, that is called increasing returns to scale. If the output increases at a lower rate than the rate at which inputs are increased, that is called decreasing returns to scale.
Economies of Scale vs Returns to Scale
Economies of scale and returns to scale are concepts related to each other even though they are terms that cannot be used interchangeably. Returns to scale refers to changes in the levels of output as inputs change, and economies of scale refers to changes in the costs per units as the number of units are increased. A firm that just has increasing returns to scale may not have economies of scale because even though output increased at a higher rate than the increases in input, scarcity of resources may have resulted in higher raw material cost and, therefore, higher per unit cost.
Summary:
• Economies of scale and returns to scale are concepts closely related to one another and describe the effects that changes in production levels and costs will have, as inputs increase.
• Economies of scale is a concept that is widely used in the study of economics and explains the reductions in cost that a firm experiences as the scale of operations increase.
• Returns to scale is a concept related to economies of scale and refers to changes that are made to a firm’s output, depending on increases in the amount of inputs made.