Economies of Scale, Diseconomies of Scale, and Constant Returns to Scale

Economies of scale, diseconomies of scale, and constant returns to scale are all related terms that describe what happens as the scale of production increases. It is important to understand the concepts of these returns to scale because they can be an important factor in determining the optimal and equilibrium size of firms. From that decision, the structure of industries and their prices and output levels can also be determined appropriately. Therefore, these factors provide major implications for public policy. Particularly, in case where they lead to the development of natural monopolies, these companies can claim themselves to be prevented from government attempts to break them up.


As can be seen in above graph, as the output(production) increases, long run average total cost curve decreases in economies of scale, constant in constant returns to scale, and increases in diseconomies of scale

For example, a factory initially expanding its output experiences decreasing long run average cost. This situation is economies of scale and there are lots of real world examples of international companies building large plant to take advantage of this situation. However, as a company passes a certain point it reaches the stage when an increase in output leading increase in average cost. This situation is diseconomies of scale. And, sometimes the technology in an industry allows a firm to produce different levels of output at the same minimum average cost and this condition can be understood as a constant return to scale.

Economies of scale

This term characterizes a production process in which an increase in the number of units produced causes a decrease in the average cost of each unit. It is also called as increasing returns to scale as it refers to the situation in which the cost of producing an additional unit of output, which is the marginal cost of a product decreases as the volume of its production increases. It could also be defined as the situation in which an equal percentage increase in all inputs results in a greater percentage increase in output.
An example of an economy of scale would be the production of any established manufacutred good would decrease with the increase in quantity produced due to the cheaper procurement of the materials needed for production.

Constant returns to scale

It refers to a technical property of production that examines changes in output subsequent a proportional change in all inputs (where all inputs increase by a constant). If output increases by that same proportional change then there are constant returns to scale (CRTS), sometimes referred to simply as returns to scale.

Diseconomies of scale

A term used to describe processes that do not conform to the definition of economies of scale due to the costs for production does not decrease with the increased production. This can happen for several reasons. First this can happen due to the prodcution rates for the creation of parts for a product may take a set amount of time therefore increasing production would still be dependent on that part for completetion. The other reason diseconomies of scale can occur is from the increased shipping costs due to distance or weight.
A good example of diseconomies of scale would be the phamacutical industry due to their high research and development costs of producing a new drug.


1. Because of the existence of economies of scale, business firms may find that:
a. each additional unit of labor is less efficient than the previous unit.
b. as more labor is added to a factory, increases in output will diminish in the short run.
c. increasing the size of a factory will result in lower average costs.
d. increasing the size of a factory will result in lower total costs.

2. Diseconomies of scale occur in the long run when
a. a firm faces a high level of sunk costs.
b. a firm pays a higher price for inputs as its level of production increases.
c. firm's long run average total cost increases with increased production.
d. the workforce demands a higher share of company profits as output increases

3. As output increases in the short run, we know that
a. total fixed costs decline
b. average fixed costs will always decline
c. average total costs will always decline
d. average variable costs will always decline


1. C
2. C, Diseconomies of scale are associated with decreasing returns to scale in the long run
3. B, the business is spreading its overhead costs over a wider range of output leading to a reduction in the fixed cost per unit


Managerial Economics and Business Strategy, Michaeal R. Baye, Fourth Edition, Chapter 5
Pittsford Highschool Econ Lecture, Costs of Production, Chapter 22