Law of returns to scale (Using traditional Method)

Law of returns to scale

The Law of returns to scale refers to the behavior of production when all factors of production are changed. The change must be in equal proportion. In other words, it is the input and output relationship in the long run where all the factors of production have a variable supply. This law states that when all factors of production are changed in the same ratio, the output will change but the change in the output may be at an increasing rate, constant rate, or decreasing rate. Thus there are the three stages of the law of returns to scale which are explained as follows:

1. Increasing returns to scale:-

When the increase in the output is in greater proportion than the increase in the inputs, 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, the marginal efficiency of capital, marketing efficiency, managerial efficiency, etc. The concept of increasing returns to scale can be explained by the help of the following schedule.

Total inputs	Total output/product
1L+1K	5
2K+2L	12
4K+4L	30

The above table shows increasing returns to scale. We can see that when we doubled the inputs, then the output is more than double.

2. Constant returns to scale:-

              When the increments in the outputs are in the same proportion as the increase in inputs, 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 schedule:

Total inputs	Total output/product
1L+1K	5
2K+2L	10
4K+4L	20

The above table shows constant returns to scale. We can see that when we doubled the inputs, then the outputs are also doubled.

3. Decreasing returns to scale:-

When the increase in the output is in less proportion than the increase in the inputs, 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 schedule.

Total inputs	Total output/product
1L+1K	5
2K+2L	8
4K+4L	12

The above table shows decreasing returns to scale. We can see that when we doubled the inputs, then the outputs are less than double.

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

In the above figure, marginal product and combination of labor and capital are shown along the y-axis and x-axis respectively. The curve OABC represents the law of returns to scale. OA curve represents increasing returns to scale, where MP increases in greater proportion than factor combinations. AB represents constant returns to scale where MP increases in equal proportion to factor combinations. BC represents decreasing returns to scale where MP increases in less proportion than factor combinations.