Law of returns to scale using isoquant

Law of returns to scale (alternative method using isoquant )

The law of returns to scale is a long term phenomenon. In the long run, all the inputs can be varied in the course of production activities. That means, in the long run, the expansion of output may be achieved by varying all the factors. So, the law of returns to scale refers to the effect of scale relationship. The traditional theory of production concentrates on the study of output as well as the input by the same proportion. If all the inputs are changed, then the law of returns to scale holds. When all inputs are increased proportionately, then there may be an increase in the output in three different ways which can be explained by the help of laws of returns to scale:

1. Increasing returns to scale:-

When the increase in the output is in greater proportion than the increase in the input, then it is the case of increasing returns to scale. For example, if all the inputs are increased by 10%, then the output increases by more than 10%. The major causes of increasing returns to scale are better combination and utilization of resources, managerial efficiency, marketing efficiency, etc. It can be explained by the help of the following diagram:

In the above figure, OR is the product line. The various isoquants; IQ1, IQ2, IQ3 are drawn which represent 100, 120, and 140 units of output respectively. A small increase in labor and capital has increased the output by a more amount. I.e. OA>AB>BC is greater than OL1>L1L2> L2L3 and OK1>K1K2> K2K3.

2. Constant returns to scale:-

              When the increments in the outputs are in the same proportion with the increase in input, then it is the case of constant returns to scale. For example; if all the inputs are increased by 10%, then the output also increases by 10%.  The concept of constant returns to scale can be explained by the help of the following diagram:

In the above figure, OR is the product line. The various isoquants; IQ1, IQ2, IQ3 are drawn which represent 10, 20, and 30 units of output respectively. Thus, the successive isoquants are equidistant from each other I.e. OA=AB=BC, OL1=L1L2= L2L3 and OK1=K1K2= K2K3.

3. Decreasing returns to scale

When the increase in the output is in less proportion than the increase in input, then it is the case of decreasing returns to scale. For example, if all the inputs are increased by 10%, then the output increases by less than 10%. The major causes of decreasing returns to scale are managerial inefficiency, poor combination, and utilization of resources, labor problem and exhaustibility of natural resources. The concept of decreasing returns to scale can be explained by the help of the following diagram:

In the above figure OR is the product line. The various isoquants; IQ1, IQ2, IQ3 are drawn which represent 10, 15, and 18 units of output respectively. The successive isoquants are farther from each other. I.e. OA<AB<BC is less than OL1<L1L2< L2L3 and OK1<K1K2<K2K3.