Marginal cost

Chapter 6: Production Magic: Pulling a Rabbit Out of the Hat

Constant returns to scale indicate that doubling the quantity employed of all inputs results in output also doubling. In the case of constant returns to scale, increasing and decreasing returns to scale essentially offset each other.

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Determining Output Elasticity

Output elasticity is the percentage change in output that results from a onepercent change in the quantity employed of all inputs. Output elasticity, therefore, is related to returns to scale. If the output elasticity is greater than one, increasing returns to scale exist. An output elasticity equal to one indicates constant returns to scale, while an output elasticity of less than one indicates decreasing returns to scale.

Consider the Cobb-Douglas production function

If you increase the quantity employed of both labor and capital by one percent, then

Rearranging the equation results in

Therefore, a one-percent increase in both labor and capital results in a onepercent increase in output, as represented by the (1.01) in the equation. This situation indicates constant returns to scale.

One special feature of Cobb-Douglas production functions is that they always have constant returns to scale. Just a final little piece of production magic.