Returns to Scale
Returns to Scale is a way to describe what happens to a production process when you add more of one factor of production. There are three types of returns - increasing, decreasing and constant.
An extreme version of decreasing returns is when additional resources lead to decrease in productivity. A humorous example of negative returns:
A manager was working on a great and difficult project. His programmers were struggling and the deadline was soon approaching. His soul was in turmoil, so he decided to seek guidance from the company's great zen programmer. He said to the zen master programmer - I have 10 programmers working on this project, and they tell me it will take them 6 months to complete the project, but I need it to completed in 4 months. What will happen if I assign another 5 programmers? The master programmer thought for a bit and replied "then the project will take 8 months." The manager was flustered and asked "what if I add another 10 programmers?" The master programmer thought a bit more and replied "one year". The manager was very upset by his response and quickly asked "what if I assign a hundred more programmers to the project?" The zen master looked at him portentiously and replied "then the project will never be completed."
Decreasing returns characterize most production methods when you consider each input one at a time. For example, adding more farmers to a plot of land will produce less food per farmer, once you get to a certain point. If there is less than a few acres of land for each farmer, the additional productivity of additional farmers will be close to zero. Malthus' Iron Law of Wages and Population Trap are based on this idea.
Constant returns to scale are boring - additional resources add the same amount of production as previous resources.
Increasing returns are the most interesting and possibly counter-intuitive. Additional resources added to a type of production not only produce as much as the last set, but actually more. Some reasons for this are comparative advantage and spreading out fixed costs or overhead. Cities often have much higher wages because populations develop increasing returns production technologies. Modern production is characterized by technologies which require a large group of highly trained people to work effectively.
An extreme version of decreasing returns is when additional resources lead to decrease in productivity. A humorous example of negative returns:
A manager was working on a great and difficult project. His programmers were struggling and the deadline was soon approaching. His soul was in turmoil, so he decided to seek guidance from the company's great zen programmer. He said to the zen master programmer - I have 10 programmers working on this project, and they tell me it will take them 6 months to complete the project, but I need it to completed in 4 months. What will happen if I assign another 5 programmers? The master programmer thought for a bit and replied "then the project will take 8 months." The manager was flustered and asked "what if I add another 10 programmers?" The master programmer thought a bit more and replied "one year". The manager was very upset by his response and quickly asked "what if I assign a hundred more programmers to the project?" The zen master looked at him portentiously and replied "then the project will never be completed."
Decreasing returns characterize most production methods when you consider each input one at a time. For example, adding more farmers to a plot of land will produce less food per farmer, once you get to a certain point. If there is less than a few acres of land for each farmer, the additional productivity of additional farmers will be close to zero. Malthus' Iron Law of Wages and Population Trap are based on this idea.
Constant returns to scale are boring - additional resources add the same amount of production as previous resources.
Increasing returns are the most interesting and possibly counter-intuitive. Additional resources added to a type of production not only produce as much as the last set, but actually more. Some reasons for this are comparative advantage and spreading out fixed costs or overhead. Cities often have much higher wages because populations develop increasing returns production technologies. Modern production is characterized by technologies which require a large group of highly trained people to work effectively.