Increasing Returns

Concept and distinctions

In economics, "returns" describe how output responds to inputs. When one input is increased while others are held fixed, additional output tends to shrink, which is the law of diminishing returns, a basic neoclassical assumption alongside diminishing marginal utility. When all inputs are increased in the same proportion and output rises by a larger proportion, this is "increasing returns to scale"; more broadly, increasing returns refers to any situation in which performance per unit improves as production or use expands. Falling average cost, or economies of scale, is a leading consequence. Adam Smith (1776) argued that larger markets deepen the division of labor and raise productivity, and Alfred Marshall (1890) described the external economies that arise when industries cluster in one place.

Growth theory and trade theory

Increasing returns sit uneasily with perfect competition: as Piero Sraffa (1926) noted, if average cost keeps falling the largest firm takes the market. The idea therefore long stayed at the margins, though Allyn Young (1928) stressed a cumulative process in which market expansion and division of labor feed each other, and Nicholas Kaldor (1966) emphasized that manufacturing productivity rises with output. From the 1980s, Paul Romer (1986, 1990) built endogenous growth theory on the insight that ideas are non-rival, usable by many at once, so knowledge accumulation yields increasing returns and sustained growth; he shared the 2018 Nobel Prize (Jones, 2019). Paul Krugman (1979, 1991) used increasing returns and monopolistic competition to explain trade between similar countries and the geographic concentration of industry, winning the 2008 Nobel Prize.

The information economy and winner-take-all

W. Brian Arthur (1994, 1996) argued that high-tech industries show strong increasing returns because high up-front development costs, near-zero copying costs, network effects and user learning reinforce one another. Small early advantages are then amplified in a Matthew effect, and markets can tip into a single standard through path-dependent lock-in. Shapiro and Varian (1999) set out the implications for pricing information goods and competing over standards. Increasing returns underpin debates about platform concentration and competition policy, though critics note that congestion and coordination costs keep them from continuing indefinitely.

FAQ

Are increasing returns the same as economies of scale?

They are closely related but not identical. Economies of scale is a cost-side concept, falling average cost as output grows, while increasing returns refers more broadly to output rising more than proportionally to inputs.

Why does knowledge generate increasing returns?

Ideas are non-rival: one person's use does not prevent others from using them at the same time, so once created they can be reused indefinitely at almost no extra cost.

Sources reviewed: 2026-10-26

References

1. Smith, A. (1776). An Inquiry into the Nature and Causes of the Wealth of Nations. London: W. Strahan and T. Cadell.
2. Marshall, A. (1890). Principles of Economics. London: Macmillan.
3. Young, A. A. (1928). Increasing returns and economic progress. Economic Journal, 38(152), 527–542.
4. Sraffa, P. (1926). The laws of returns under competitive conditions. Economic Journal, 36(144), 535–550.
5. Kaldor, N. (1966). Causes of the Slow Rate of Economic Growth of the United Kingdom. Cambridge: Cambridge University Press.
6. Romer, P. M. (1986). Increasing returns and long-run growth. Journal of Political Economy, 94(5), 1002–1037.
7. Romer, P. M. (1990). Endogenous technological change. Journal of Political Economy, 98(5), S71–S102.
8. Krugman, P. (1979). Increasing returns, monopolistic competition, and international trade. Journal of International Economics, 9(4), 469–479.
9. Krugman, P. (1991). Increasing returns and economic geography. Journal of Political Economy, 99(3), 483–499.
10. Arthur, W. B. (1994). Increasing Returns and Path Dependence in the Economy. Ann Arbor: University of Michigan Press.
11. Arthur, W. B. (1996). Increasing returns and the new world of business. Harvard Business Review, 74(4), 100–109.
12. Shapiro, C., & Varian, H. R. (1999). Information Rules. Boston: Harvard Business School Press.
13. Jones, C. I. (2019). Paul Romer: Ideas, nonrivalry, and endogenous growth. Scandinavian Journal of Economics, 121(3), 859–883.