Question

if a 10-percent increase in both capital and labor causes output to increase by less than 10 percent, the production function is said to exhibit decreasing returns to scale. if it causes output to increase by more than 10 percent, the production function is said to exhibit increasing return to scale. why might a production function exhibit decreasing or increasing returns to scale?

Answer 1

Production function can exhibit increasing returns to scale due to economies of scale. If production is done on large scale that per unit labor and capital is less and it contributes more to output. Production function can exhibit decreasing returns to scale due to diseconomies of scale, where every unit of labor and capital does not increase output by the same proportion.