Returns to Scale

Returns to scale indicate by how much the production is multiplied when the firm multiplies Capital and Labor by the same factor.

Example

A production function can have decreasing returns to scale, constant returns to scale, or increasing returns to scale.

Let the production function be `q \left( K, L \right) = K^{0.2} L^{0.3}`. Multiplying the capital (K) and labor (L) by the same factor `\lambda > 1` gives

$$ \begin{align*} q \left( \lambda K, \lambda L \right) &= \left( \lambda K \right)^{0.2} \left( \lambda L \right)^{0.3} \\ &= \lambda^{0.2} K^{0.2} \lambda^{0.3} L^{0.3} \\ &= \lambda^{0.5} K^{0.2} L^{0.3} \\ &= \lambda^{0.5} q \left( K, L \right) < \lambda q \left( K, L \right) \end{align*} $$

Multiplying by 4 the number of ovens (K) and grandmas (L) in the cookie factory will multiply the number of cookies by `4^{0.5} = 2`.

Let the production function be `q \left( K, L \right) = K^{0.3} L^{0.7}`. Multiplying the capital (K) and labor (L) by the same factor `\lambda > 1` gives

$$ \begin{align*} q \left( \lambda K, \lambda L \right) &= \left( \lambda K \right)^{0.3} \left( \lambda L\right)^{0.7} \\ &= \lambda^{0.3} K^{0.3} \lambda^{0.7} L^{0.7} \\ &= \lambda^{1} K^{0.3} L^{0.7} \\ &= \lambda q \left( K, L \right) \end{align*} $$

Multiplying by 2 the number of ovens (K) and grandmas (L) in the cookie factory will multiply the number of cookies by `2`.

Let the production function be `q \left( K, L \right) = K^{3} L`. Multiplying the capital (K) and labor (L) by the same factor `\lambda > 1` gives

$$ \begin{align*} q \left( \lambda K, \lambda L \right) &= \left( \lambda K \right)^{3} \left( \lambda L \right)\\ &= \lambda^{3} K^{3} \lambda L \\ &= \lambda^{3} K^{3} L \\ &= \lambda^{3} q \left( K, L \right)> \lambda q \left( K, L \right) \end{align*} $$

Multiplying by 2 the number of ovens (K) and grandmas (L) in the cookie factory will multiply the number of cookies by `2^3=8`.

Question

The cookie factory has the following production function: `q \left( K, L \right) = K^{0.18} L^{0.89}`.

Determine whether the factory has decreasing, constant or increasing returns to scale.

Let `\lambda > 1`.

$$ \begin{align*} q \left( \lambda K, \lambda L \right) &= \left( \lambda K \right)^{0.18} \left( \lambda L \right)^{0.89} \\ &= \lambda^{0.18} K^{0.18} \lambda^{0.89} L^{0.89} \\ &= \lambda^{0.18 + 0.89} K^{0.18} L^{0.89} \\ &= \lambda^{1.07} K^{0.18} L^{0.89} \\ &= \lambda^{1.07} q \left( K, L \right) \\ & > \lambda q \left( K, L \right) \end{align*} $$ The production function has increasing returns to scale.