Returns to Scale Measurement

If output grows faster than inputs, holding technology constant, the production function exhibits increasing returns to scale. Increasing returns in the aggregate production function may be due to overhead (fixed) costs, diminishing marginal cost, positive spillovers from aggregate activity, the entry of new varieties of inputs or changes in the distribution of inputs across heterogeneous firms. Each channel has significant implications for models of growth, trade and business cycles. Returns to scale are hard to estimate and even difficult to define, since the definition may depend on the degree of aggregation and the time horizon under study.