Returns to scale describes the long-run linkage of increase in output relative to associated increases in inputs for a firm. This concept explains how production changes when all factors of production are variable and subject to change over time.
Constant returns to scale occurs when output increases by the same proportional change as all inputs change. For example, if labor and capital increase by 100%, output increases by exactly 100% while maintaining constant long-run average costs.
Decreasing returns to scale exist when output increases by less than the proportional change in all inputs. Management difficulties and lack of coordination in all stages of production lead to decreased efficiency when inputs rise but output rises by less than that amount.
Increasing returns to scale appear when output increases by more than the proportional change in all inputs. An input increase of 100% resulting in an output greater than 100% signals rising production efficiency due to expansion and more streamlined technology.
The Cobb-Douglas production function illustrates these concepts with specific parameters regarding exponents. For a value greater than 1, there are increasing returns if the sum of exponents exceeds 1, constant returns if the sum equals 1, and decreasing returns if the sum remains below 1.