Returns to scale refer to the returns enjoyed by the firm as a result of change in all the inputs. It explains the behaviour of the returns when the inputs are changed simultaneously. The returns to scale are governed by laws of returns to scale.
Production function using all variables (land, labour and capital)
Many people confuse Economies of Scale with the concept of increasing returns to scale. Economies of scale are related with to money costs of production whereas returns to scale are related only with the physical output of the factors or production. If physical output increases more than proportionately as the scale of all the inputs is changed, increasing returns to scale occur. Decreasing returns to scale and constant returns to scale are other possibilities. Increasing returns to scale contribute to economies of scale in the form of technical economies. It is the impact of diminishing marginal returns on costs and profits of a firm in economic short run that encourages the firm to change the scale of its operations in long run.
Increase in all inputs of productions made lead different effects and situation. There are three possible situations may occur in the output: