The Law Of Returns To The Law Of Returns To ScaleScale

The Laws Of Returns To The Laws Of Returns To ScaleScale

• The laws of returns to scale explain The laws of returns to scale explain the behavior of output in response to the behavior of output in response to a proportional and simultaneous a proportional and simultaneous change in inputs. Increasing inputs change in inputs. Increasing inputs proportionately and simultaneously proportionately and simultaneously is, in fact, an expansion of the scale is, in fact, an expansion of the scale of production.of production.

• When a firm increases both the inputs When a firm increases both the inputs proportionately, there are three possibilitiesproportionately, there are three possibilities

1.1. Total output may increase more than Total output may increase more than proportionatelyproportionately

2.2. Total output may increase proportionatelyTotal output may increase proportionately3.3. Total output may increase less than proportionatelyTotal output may increase less than proportionately

Accordingly, there are three kinds of return to scaleAccordingly, there are three kinds of return to scale1.1. Increasing returns to scaleIncreasing returns to scale2.2. Constant returns To ScaleConstant returns To Scale3.3. Decreasing returns to scaleDecreasing returns to scale

Increasing Returns to ScaleIncreasing Returns to Scale

The Causes of Increasing The Causes of Increasing Returns To ScaleReturns To Scale

1.1. Technical and managerial Technical and managerial indivisibilitiesindivisibilities

2.2. Higher degree of specializationHigher degree of specialization

3.3. Dimensional relationsDimensional relations

Constant returns to scaleConstant returns to scale

• When the change in output is When the change in output is proportional to the change in inputs, proportional to the change in inputs, it exhibits constant returns to scale.it exhibits constant returns to scale.

Constant returns to scaleConstant returns to scale

Constant returns to scaleConstant returns to scale

• The constant returns to scale are The constant returns to scale are attributed to the limits of the attributed to the limits of the economies of scale. With expansion in economies of scale. With expansion in the scale of production, economies the scale of production, economies arise from such factors as indivisibility arise from such factors as indivisibility of fixed factors, greater possibility of of fixed factors, greater possibility of specialization of capital and labor, use specialization of capital and labor, use of labor saving techniques of of labor saving techniques of production, etc.production, etc.

Decreasing returns to scaleDecreasing returns to scale

Decreasing returns to scaleDecreasing returns to scale

• The firms are faced with decreasing The firms are faced with decreasing returns to scale when a certain returns to scale when a certain proportionate change in inputs, k & l, proportionate change in inputs, k & l, lead to less than proportionate lead to less than proportionate change in output.change in output.

Causes of Diminishing return to Causes of Diminishing return to scalescale

• The decreasing returns to scale are The decreasing returns to scale are attributed to the diseconomies of attributed to the diseconomies of scale. The most important factor scale. The most important factor causing this is ‘the diminishing return causing this is ‘the diminishing return to management’. Another factor is to management’. Another factor is the exhaustibility of natural the exhaustibility of natural resources. resources.