Difference between Returns to Scale and Economies of Scale
This article will help you to learn about the difference between returns to scale and economies of scale.
Returns to scale return to the technical relationship between a portionate change in all factors (the size or scale of single plant) and the resulting change in output. Thus, returns to scale refer to changes made by a firm at the plant level. There are, however, factors external to the firm that can also affect the profitability of the firm by altering factor cost.
When we consider the possibility of changes in the factors external to the firm, the concept of economies or diseconomies of scale assumes significance. All firms must buy their inputs from the market. As an industry (with all its associated firms) expands, new and more efficient methods may be developed by factor suppliers.
That is, expansion in one industry, say, the coal industry, which requires inputs from another industry, say, the steel industry, may create incentives for the steel industry to develop new and less costly production techniques. The reduced price of these inputs will thus lead to lower prices of steel to all firms in the coal industry, or what is known as scale economies. Diseconomies of scale would result if expansion in one industry led to a rise in price of factors purchased from other industries.
Returns to scale occur within a firm: economies of scale refer to factors that are external to the firm. It is essential for production managers to understand, for example, whether its costs of operation are rising because of internal scale factors that it can alter or forces which are external to and beyond its control.
Production control managers must be aware of unit costs of production, and must have an insight as to what can happen when the firm and the industry expand. Increasing the scale of a plant may lower unit costs due to increasing returns to scale. This could be neutralized partly, at least, if the industry expanded simultaneously and incurred diseconomies due to increasing factor prices.