Crime Against Humanity: Pensée Unique in Economics, 13
When Wil Coyote barely gets back up, next to him in the dust he notices the ancillary neoclassical tenets: “perfect information”, “perfect competition”, “maximum capacity utilisation”, “constant or diminishing returns to scale”.
Knowing that the most important thing in learning is detecting and defining the unknown or misunderstood terms, and doing it right away because everything from an unknown or misunderstood term onward is a ruinous but unnoticed messy vacuum, he decides to hurry back to the big books in his lair to review these tenets, and to do so starting from the most incomprehensible.
What are constant or diminishing returns to scale?
Wil Coyote clarifies what he reads by drawing it. He draws a rectangle: this is a production entity, something that produces something. Then he draws a few arrows pointing to the rectangle and labels them “input”: these are the factors of production entering the entity. Then he draws an arrow pointing from the entity outwards and labels it “output”: this is its production getting out of it. If you measure the amounts of input and output, you have their scale. If you compare them with one another, you have their ratio. Then he takes another sheet, repeats the same drawing, but this time much bigger, and mutters to himself:
“These two entities are of the same type with the same type of input and output, and their only difference is the scale: one is smaller and the other is bigger; let’s say the size of the rectangle, of the input and of the output of the second is ten times that of the first. This is their difference in terms of scale; the question is, is there a difference between them in terms of input−output ratio?
Suppose that the input and output of the smaller one are both 10; its output−to−input ratio is 10 divided by 10: 1. Then suppose that the input and output of the bigger one are both 100; its output−to−input ratio is 100 divided by 100: here too, 1. In this case, increasing the scale, the ratio remains the same; this is called: constant returns to scale.
Then suppose that the input of the bigger one remains 100 but its output is 50; its output−to−input ratio is 50 divided by 100: 0.5. In this case, increasing the scale, the ratio lowers; this is called: diminishing returns to scale.
Finally suppose that the input of the bigger one remains 100 but its output is 200; its output−to−input ratio is 200 divided by 100: 2. In this case, increasing the scale, the ratio rises; this is called: increasing returns to scale.
