Note on Laws of Return to Scale

  • Note
  • Things to remember

LAW OF RETURN TO SCALE

Law of Return to Scale is a long-run concept. It is also called long run production function. In this, the factors of input are variable.

“The term returns to scale refers to the changes in output as all factors change by the same proportion.” Koutsoyiannis

This law can be written as:-

Q = F (K, L)

where,

Q is output

K is capital

L is labour

The law of return to scale states that if both factors of inputs are to be varied in a fixed proportion, then the production function shows 3 types of relationship in long run. They are:

  • Increase returns to scale
  • Decreasing returns to scale
  • Constant returns to scale

s

  • Increasing Returns to Scale (IRS)

If output increases by more than a proportional increase in inputs, the production is said to be increasing returns to scale. It means if all inputs are doubled, output will also increase at the faster rate than double.In other words, percentage change in output is more than the percentage change in inputs.

It can be explained by the following table:

Unit of labour Unit of capital Total unit of input TP MP
1L 1K 1L+1K 500 500
2L 2K 2L+2K 1200 7000
3L 3K 3L+3K 2500 1300

From the above table, we can see one unit of labour and capital produce 500 units of output. When both inputs are increased by 100% i.e. 2L and 2K the level of output is 1200 units which is more than 100% change. Here, a percentage change in output is more than the percentage change in input which shows increasing return to scale.

It can be represented diagrammatically as:

s


In the given figure, capital and labour are shown in X-axis and TP of returns is shown in Y-axis. As shown in the graph, TP is increasing returns to scale in units of labour and capital. The positive curve sloping upwards shows the increasing returns to scale. The combination points a, b, c are the increasing trend of TP.

The reason for increasing returns to scale are as follows:

  1. Internal and external economics
  2. Discount in price of raw materials
  3. Specialisation of labour

  • Decreasing Returns to Scale (DRS)

If output increases by less than proportionate increase return in input, then, it is called decreasing returns to scale. It means, if inputs are doubled, output will be less than doubled. In other words, a percentage increase in output is less than the percentage increase in input.

Unit of labour Unit of capital Total unit of input TP MP
1L 1K 1L+1K 500 500
2L 2K 2L+2K 900 400
3L 3K 3L+3K 1100 200

From the above table, we can see one unit of labour and capital produces 500 units of output.When both inputs are increased by 100% i.e 2L and 2K,the level of output is 900 units which are less than 100% change. Here, a percentage change in output is less than the percentage change in input which shows increasing returns to scale.

It can be represented diagrammatically as:


s

In the given figure, capital and labour are shown in X-axis and TP of returns is shown in Y-axis. As shown in the graph, TP continuously increases with the decrease rate with the increase in the variable factors inputs. The combination point a, b, c shows the decreasing trend of MP.

The main reason for the decreasing returns to scale are as follow:

  1. Entrepreneurship is a fixed
  2. Lack of natural factors
  3. Internal and external diseconomies of scale

  • Constant Returns to Scale (CRS)

If there equal percentage change in output and input, it is called constant returns to scale.In simple terms, if factors of production are doubled output will also be doubled. In other words, a percentage increase in output is equal to percentage change in input.

Unit of labour Unit of Capital Total unit of Input TP MP
1L 1K 1L+1K 500 500
2L 2K 2L+2k 1000 500
3L 3K 3L+3k 1500 500
4L 4K 4L+4K 2000 500

From the above table, we can see one unit of labour and capital produces 500 units of output. When both inputs are increased by 100% i.e 2L and 2K,the level of output increases to 1000 units which are exactly 100% change. Here, a percentage change in output is equal to the percentage in input which shows constant returns to scale.

This can be shown in the following figure:


s

In the given figure, capital and labour are shown in X-axis and TP of returns is shown in Y-axis. We can see that marginal production rises with the increasing returns to scale remain constant with constant returns to scale and declines with decreasing returns to scale. The combination of points a, b, c shows the constant returns to scale.

(Karna, Khanal, and Chaulagain)(Khanal, Khatiwada, and Thapa)(Jha, Bhusal, and Bista)

Bibliography

Jha, P.K., et al. Economics II. Kalimati, Kathmandu: Dreamland Publication, 2011.

Karna, Dr.Surendra Labh, Bhawani Prasad Khanal and Neelam Prasad Chaulagain. Economics. Kathmandu: Jupiter Publisher and Distributors Pvt. Ltd, 2070.

Khanal, Dr. Rajesh Keshar, et al. Economics II. Kathmandu: Januka Publication Pvt. Ltd., 2013.

  1. Laws of return to scale is a long-run concept. It is also called long run production function.

The production function shows 3 types of relationship in long run they are:

  1. Increase returns to scale
  2. Decreasing returns to scale
  3. Constant returns to scale
.

Very Short Questions

0%

DISCUSSIONS ABOUT THIS NOTE

No discussion on this note yet. Be first to comment on this note