Laws of Returns to Scale

Laws Of Returns To Scale

In the long- run, there is no fixed factor; all factors are variable. The laws of returns to scale explain the relationship between output and the scale of inputs in the long-run when all the inputs are increased in the same proportion.

Assumptions

Laws of Returns to Scale are based on the following assumptions.

·           All the factors of production (such as land, labour and capital) are variable but organization is fixed.

·           There is no change in technology.

·           There is perfect competition in the market.

·           Outputs or returns are measured in physical quantities.

Three Phases of Returns to Scale

1. Increasing Returns to Scale:

In this case if all inputs are increased by one per cent, output increase by more than one per cent.

2. Constant Returns to Scale:

In this case if all inputs are increased by one per cen, output increases exactly by one per cent.

3. Diminishing Returns to Scale: Diminishing Returns to Scale:

In this case if all inputs are increased by one per cent, output increases by less than one per cent.

Diagrammatic Illustration

The three laws of returns to scale can be explained with the help of the diagram below.

In the diagram 3.2, the movement from point a to point b represents increasing returns to scale. Because, between these two points output has doubled, but output has tripled.

The law of constant returns to scale is implied by the movement from the point b to point c. Because, between these two points inputs have doubled and output also has doubled.

Decreasing returns to scale are denoted by the movement from the point c to point d since doubling the factors from 4 units to 8 units produce less than the increase in inputs, that is, by only 33.33%