The correct answer is: Both 1 and 2 are correct.
Returns to scale is the relationship between the amount of inputs used in production and the amount of output produced. When all inputs are increased by the same proportion, there are three possible outcomes:
- Constant returns to scale: If output increases by the same proportion as the inputs, then there are constant returns to scale. This means that the production process is efficient and that there are no economies or diseconomies of scale.
- Decreasing returns to scale: If output increases by less than the proportion of the inputs, then there are decreasing returns to scale. This means that the production process is inefficient and that there are diseconomies of scale.
- Increasing returns to scale: If output increases by more than the proportion of the inputs, then there are increasing returns to scale. This means that the production process is efficient and that there are economies of scale.
In order to achieve constant returns to scale, the quantities of the various factors of production must be varied simultaneously and proportionately. This means that if the amount of labor is doubled, then the amount of capital must also be doubled. If the amount of land is tripled, then the amount of labor and capital must also be tripled.
If the quantities of the various factors of production are not varied simultaneously and proportionately, then the production process will not be efficient and there will be either diseconomies or economies of scale.