Relationship between returns to scale and economies of scale
Is it true that increasing returns to scale leads to economies of scale? Or is it that economies of scale leads to increasing returns to scale? Or is it just that the two occur together coincidentally - I feel as though this is wrong but please correct me if I'm wrong
I can't seem to find out on the Internet because there appear to be contradicting answers. If anyone could clarify and explain why, it would be much appreciated
I can't seem to find out on the Internet because there appear to be contradicting answers. If anyone could clarify and explain why, it would be much appreciated
Returns to Scale -> changes in output when factors of production are increased
Economies of Scale -> reduction in average unit costs as output increases.
-> I would say they go hand in hand - when there are increasing returns to scale, the %Change in output > %Change in input. This implies that the firm experiences economies of scale because, as it increases the scale of production, it becomes more efficient and can spread fixed costs over a larger output. In other words, as the input increases, output increases at a faster rate, leading to a reduction in average cost per unit of output.
This also works with constant and diminishing returns to scale. If you look at the standard diagram for economies of scale ( U shaped with the straighter line in the middle) you can identify:
-> increasing returns to scale & economies of scale as the first third (downward sloping LRAC)
-> constant returns to scale as the second third (straight line of the LRAC)
-> decreasing returns to scale & diseconomies of scale as the last third (upward sloping LRAC)
Economies of Scale -> reduction in average unit costs as output increases.
-> I would say they go hand in hand - when there are increasing returns to scale, the %Change in output > %Change in input. This implies that the firm experiences economies of scale because, as it increases the scale of production, it becomes more efficient and can spread fixed costs over a larger output. In other words, as the input increases, output increases at a faster rate, leading to a reduction in average cost per unit of output.
This also works with constant and diminishing returns to scale. If you look at the standard diagram for economies of scale ( U shaped with the straighter line in the middle) you can identify:
-> increasing returns to scale & economies of scale as the first third (downward sloping LRAC)
-> constant returns to scale as the second third (straight line of the LRAC)
-> decreasing returns to scale & diseconomies of scale as the last third (upward sloping LRAC)
Original post by DishPerson :)
Is it true that increasing returns to scale leads to economies of scale? Or is it that economies of scale leads to increasing returns to scale? Or is it just that the two occur together coincidentally - I feel as though this is wrong but please correct me if I'm wrong
I can't seem to find out on the Internet because there appear to be contradicting answers. If anyone could clarify and explain why, it would be much appreciated
I can't seem to find out on the Internet because there appear to be contradicting answers. If anyone could clarify and explain why, it would be much appreciated
also to add - the only distinction between the two concepts which you should be aware of, is that economies of scale is more cost-related, whereas returns to scale focuses more on the output side. (as stated in definitions)
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