Table 1: Returns to Scale
| Unit | Scale of Production | Total Returns | Marginal Returns |
| 1 | 1 Labor + 2 Acres of Land | 4 | 4 (Stage I - Increasing Returns) |
| 2 | 2 Labor + 4 Acres of Land | 10 | 6 |
| 3 | 3 Labor + 6 Acres of Land | 18 | 8 |
| 4 | 4 Labor + 8 Acres of Land | 28 | 10 (Stage II - Constant Returns) |
What are the laws of returns to scale in economics?
Generally, laws of returns to scale refer to an increase in output due to increase in all factors in the same proportion. Such an increase is called returns to scale. Now, if both the factors of production i.e., labour and capital are increased in same proportion i.e., x, product function will be rewritten as.
What is the law of diminishing returns to scale?
Diminishing Returns to Scale In the long run, output can be increased by increasing all factors in the same proportion. Generally, laws of returns to scale refer to an increase in output due to increase in all factors in the same proportion. Such an increase is called returns to scale.
What do you mean by ‘returns to scale’?
The term ‘returns to scale’ refers to the changes in output as all factors change by the same proportion. and we increase all the factors by the same proportion k. We will clearly obtain a new level of output X*, higher than the original level X 0,
What is the relationship between production and returns to scale?
If the proportional change in the output of an organization is greater than the proportional change in inputs, the production is said to reflect increasing returns to scale.
What are the 3 laws of returns to scale?
Three phases of returns to scale There are three phases of returns in the long run which may be separately described as (1) the law of increasing returns (2) the law of constant returns and (3) the law of decreasing returns.
What is meant by returns to scale?
Returns to scale refers to the rate by which output changes if all inputs are changed by the same factor. Constant returns to scale: a k-fold change in all inputs leads to a k-fold change in output.
Who gave law of returns to scale?
Cobb-Douglas linear homogenous production function is a good example of this kind. This is shown in diagram 10. In figure 10, we see that increase in factors of production i.e. labour and capital are equal to the proportion of output increase. Therefore, the result is constant returns to scale.
What is return to scale with example?
For example, if a soap manufacturer doubles its total input but gets only a 40% increase in total output, it can be said to have experienced decreasing returns to scale. If the same manufacturer ends up doubling its total output, it has achieved constant returns to scale.
What is law of returns in economics?
The law of diminishing returns is an economic principle stating that as investment in a particular area increases, the rate of profit from that investment, after a certain point, cannot continue to increase if other variables remain at a constant.
How many laws of return are there?
three laws of returnsEarlier economists differentiated between three laws of returns also referred to as laws of production viz., law of diminishing, increasing and constant returns. Modern economists are of the view that these three laws are really three aspects of same law viz., the Law of variable proportions.
What is assumption of law of Return to Scale?
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.
How do you calculate returns to scale?
The easiest way to find out if a production function has increasing, decreasing, or constant returns to scale is to multiply each input in the function with a positive constant, (t > 0), and then see if the whole production function is multiplied with a number that is higher, lower, or equal to that constant.
What is return to scale in business?
returns to scale, in economics, the quantitative change in output of a firm or industry resulting from a proportionate increase in all inputs.
How do you calculate returns to scale?
The easiest way to find out if a production function has increasing, decreasing, or constant returns to scale is to multiply each input in the function with a positive constant, (t > 0), and then see if the whole production function is multiplied with a number that is higher, lower, or equal to that constant.
What are returns to scale how do they arise?
Returns to scale in microeconomics describe a production situation that occurs in the long run when the scale of production increases when all inputs used are variable, which affects the output level. A proportionate change in output results from a proportionate change in input.
What is the difference between returns to scale and economies of scale?
Returns to scale refers to changes in the levels of output as inputs change, and economies of scale refers to changes in the costs per units as the number of units are increased.
What is the law of returns to scale?
The law of returns to scale explains the proportional change in output with respect to proportional change in inputs. In other words, the law of returns to scale states when there are a proportionate change in the amounts of inputs, the behavior of output also changes. The degree of change in output varies with change in the amount of inputs.
How many categories are there in law of returns?
On the basis of these possibilities, law of returns can be classified into three categories:
What is diminishing returns to scale?
Diminishing returns to scale refers to a situation when the proportionate change in output is less than the proportionate change in input. For example, when capital and labor is doubled but the output generated is less than doubled, the returns to scale would be termed as diminishing returns to scale.
What is the proportional change in output of an organization?
If the proportional change in the output of an organization is greater than the proportional change in inputs, the production is said to reflect increasing returns to scale. For example, to produce a particular product, if the quantity of inputs is doubled and the increase in output is more than double, it is said to be an increasing returns to scale. When there is an increase in the scale of production, the average cost per unit produced is lower. This is because at this stage an organization enjoys high economies of scale.
Why are returns to scale diminishing?
Diminishing returns to scale is due to diseconomies of scale, which arises because of the managerial inefficiency. Generally, managerial inefficiency takes place in large-scale organizations. Another cause of diminishing returns to scale is limited natural resources.
When is a production constant?
The production is said to generate constant returns to scale when the proportionate change in input is equal to the proportionate change in output. For example, when inputs are doubled, so output should also be doubled, then it is a case of constant returns to scale.
What is the degree of change in output?
The degree of change in output varies with change in the amount of inputs. For example, an output may change by a large proportion, same proportion, or small proportion with respect to change in input. ADVERTISEMENTS:
What is the law of returns to scale states?
Before we discuss what the law of returns to scale states, let's be sure we understand the concept of production function . The production function is a highly abstract concept that has been developed to deal with the technological aspects of the theory of production. A production function is an equation, table or graph, which specifies the maximum quantity of output, which can be obtained, with each set of inputs. An input is any good or service that goes into production, and an output is any good or service that comes out of the production process. Prof. Richard H. Leftwich attributes that production function refers to the relationship between inputs and outputs at a given period. Here inputs mean all the resources such as land, labor, capital and organization used by a firm, and outputs mean any goods or services produced by the firm.
What is a production function that shows constant returns to scale called?
A production function showing constant returns to scale is often called ‘linear and homogeneous’ or ‘homogeneous of the first degree.’ For example, the Cobb-Douglas production function is a linear and homogeneous production function.
What is the stage 2 of scale?
In figure 1, the stage II represents constant returns to scale. During this stage, the economies accrued during the first stage start vanishing and diseconomies arise. Diseconomies refers to the limiting factors for the firm’s expansion. Emergence of diseconomies is a natural process when a firm expands beyond certain stage. In the stage II, the economies and diseconomies of scale are exactly in balance over a particular range of output. When a firm is at constant returns to scale, an increase in all inputs leads to a proportionate increase in output but to an extent.
What does the production function tell us?
From the above equation, we can understand that the production function tells us the relationship between various inputs and outputs. However, it does not say anything about the combination of inputs. The optimal combination of inputs can be derived from the technique of isoquant and isocost line.
How many phases of returns are there?
Three phases of returns to scale. There are three phases of returns in the long-run which may be separately described as (1) the law of increasing returns (2) the law of constant returns and (3) the law of decreasing returns. Depending on whether the proportionate change in output equals, exceeds, or falls short of the proportionate change in both ...
What is the law of organization based on?
This law is based on the following assumptions: All the factors of production (such as land, labor and capital) but organization are variable. The law assumes constant technological state. It means that there is no change in technology during the time considered. The market is perfectly competitive.
What is stage 1 of the economy?
In figure 1, stage I represents increasing returns to scale. During this stage, the firm enjoys various internal and external economies such as dimensional economies, economies flowing from indivisibility, economies of specialization, technical economies, managerial economies and marketing economies. Economies simply mean advantages for the firm. Due to these economies, the firm realizes increasing returns to scale. Marshall explains increasing returns in terms of “increased efficiency” of labor and capital in the improved organization with the expanding scale of output and employment factor unit. It is referred to as the economy of organization in the earlier stages of production.
Definition (Statement)
The law of returns are often confused with the law of returns to scale. The law of returns operates in the short period. It explains the production behavior of the firm with one factor variable while other factors are kept constant.
Explanation
These three laws of returns to scale are now explained, in brief, under separate heads.
Diagram
The three laws of returns to scale are now explained with the help of a diagram below:
What is a declining return to scale?
Decreasing Returns to Scale (DRS) occurs when a proportionate increase in all inputs results in a rise in output by a smaller proportion.
Why does the law of variable proportions emerge?
The law of variable proportions emerges because factor proportions change as long as one factor is held unchanged and the other is raised. What if both factors can change (differ)?
When a proportionate increase in all inputs results in the rise in output by the same proportion, the production function?
When a proportionate increase in all inputs results in the rise in output by the same proportion, the production function is said to exhibit Constant returns to scale (CRS).
What is Returns to Scale?
Returns to scale imply the behavior of output when all the factor inputs are changed in the same proportion given the same technology.
What are the assumptions of returns to scale?
The assumptions of returns to scale are as follows: The firm is using only two factors of production that are capital and labour. Labour and capital are combined in one fixed proportion. Prices of factors do not change. State of technology is fixed.
What is constant return to scale?
A constant return to scale implies the situation in which an increase in output is equal to the increase in factor inputs.
When there is an increase in the scale of production, the average cost per unit produced is lower?
This is because at this stage an organisation enjoys high economies of scale. Figure 1 shows the increasing returns to scale:
How to determine returns to scale?
Returns to scale are determined by analyzing the firm's long-run production function, which gives output quantity as a function of the amount of capital (K) and the amount of labor (L) that the firm uses, as shown above. Let's discuss each of the possibilities in turn.
What is the relationship between returns to scale and economies of scale?
Note the use of the word "could" in the statements above- in these cases, the relationship between returns to scale and economies of scale depends on where the tradeoff between the change in the price of the inputs and the changes in production efficiency falls.
What are some examples of decreasing returns to scale?
Common examples of decreasing returns to scale are found in many agricultural and natural resource extraction industries. In these industries, it's often the case that increasing output gets more and more difficult as the operation grows in scale- quite literally because of the concept of going for the "low-hanging fruit" first!
When does declining returns to scale happen?
Decreasing returns to scale happen when diseconomies of scale are present, and vice versa.
Why do firms exhibit increasing returns to scale?
A firm or production process could exhibit increasing returns to scale if, for instance, the larger amount of capital and labor enables the capital and labor to specialize more effectively than it could in a smaller operation. It's often assumed that companies always enjoy increasing returns to scale, but, as we'll see shortly, ...
When does increasing returns to scale occur?
For example, a firm exhibits increasing returns to scale if its output more than doubles when all of its inputs are doubled. This relationship is shown by the first expression above. Equivalently, one could say that increasing returns to scale occur when it requires less than double the number of inputs in order to produce twice as much output.
When does a firm have constant returns to scale?
Constant returns to scale occur when a firm's output exactly scales in comparison to its inputs. For example, a firm exhibits constant returns to scale if its output exactly doubles when all of its inputs are doubled. This relationship is shown by the first expression above. Equivalently, one could say that increasing returns to scale occur when it requires exactly double the number of inputs in order to produce twice as much output.
What is the return to scale of production?
By “returns to scale” is meant the behaviour of production 6r returns when all the productive factors are increased or decreased- simultaneously and in the same ratio.
What happens to all the necessary factors of production in returns to scale?
In returns to scale, on the other hand, all the necessary factors of production are increased/decrease to the same extend so that whatever be the scale of production, the proportion among the factors remains the same.
How many quintals are there in a 3 acre scale?
In the above table, we see that at the outset when we employ one worker on three acres, of land, the total product is 2 quintals. Now to increase output, we double the scale, but the total product increases to more than double (to 5 quintals instead of 4 quintals) and when the scale is trebled, the total product increases from 5 quintals to 9 quintals—the increase this time being 4 quintals as against 3 in the previous case.
What happens to marginal product when scale is increased?
If the scale of production is further increased, the marginal product remains constant up to a certain point and, beyond it, it (the marginal product) starts diminishing. In the above table at Serial No. 9 the marginal product or return falls to only two quintals.
What happens when scale is increased beyond serial number 6?
But when scale is increased beyond Serial No.6, the scope for division of labour is reduced with the result that the marginal return or product begins to decline. In short, the main underlying cause of the changing returns to scale is the possibility or otherwise of the division of labour or specialisation.
Does the output increase or decrease strictly according to the change in the scale?
A layman, uninitiated into the techniques of economic analysis, would perhaps expect that, with the doubling of all productive factors, the output would also double and with trebling of all factors of production, production would also be trebled, and so on. But actually this is not so. In other words, actually the output or returns do not increase/decrease strictly according to the change in the scale. We know that in the case of the Law of Variable Proportions, as we increase some of the co-operating factors, the marginal product or returns increases at first, and then stays constant and ultimately it starts diminishing.
Is the return to scale constant?
The returns to scale may clearly be distinguished from the Law of Variable Proportions, in which while some co-operating factors of production may be increased, (or decreased), at least one factor (e.g., land in agriculture) remains constant or cannot be increased (e.g., the entrepreneur in industry), so that the proportion among the factors of production changes and we see how returns or output is affected by such changes in the supply of the productive resources.
What is the law of returns to scale?
The laws of returns to scale refer to the effects of scale relationships. In the long run output may be increased by changing all factors by the same proportion, or by different proportions. Traditional theory of production concentrates on the first case, that is, the study of output as all inputs change by the same proportion.
How are returns to scale measured?
Returns to scale are measured mathematically by the coefficients of the production function. For example, in a Cobb-Douglas function
What is the law of diminishing returns of the variable factor?
The expansion of output with one factor (at least) constant is described by the law of (eventually) diminishing returns of the variable factor, which is often referred to as the law of variable proportions.
Why is scale increasing?
The increasing returns to scale are due to technical and/or managerial indivisibilities. Usually most processes can be duplicated, but it may not be possible to halve them. One of the basic characteristics of advanced industrial technology is the existence of ‘mass-production’ methods over large sections of manufacturing industry. ‘Mass- production’ methods (like the assembly line in the motor-car industry) are processes available only when the level of output is large. They are more efficient than the best available processes for producing small levels of output.
What is the law of production?
The laws of production describe the technically possible ways of increasing the level of production. Output may increase in various ways. Output can be increased by changing all factors of production. Clearly this is possible only in the long run. Thus the laws of returns to scale refer to the long-run analysis of production.
Do returns to scale vary over different ranges?
However, the technological conditions of production may be such that returns to scale may vary over different ranges of output. Over some range we may have constant returns to scale, while over another range we may have increasing or decreasing returns to scale. In figure 3.21 we see that up to the level of output 4X returns to scale are constant; beyond that level of output returns to scale are decreasing. Production functions with varying returns to scale are difficult to handle and economists usually ignore them for the analysis of production.
Is the K/L ratio the same for all processes?
The K/L ratio is the same for all processes and each process can be duplicated (but not halved). Each process has a different ‘unit’-level. The larger-scale processes are technically more productive than the smaller-scale processes. Clearly if the larger-scale processes were equally productive as the smaller-scale methods, no firm would use them: the firm would prefer to duplicate the smaller scale already used, with which it is already familiar. Although each process shows, taken by itself, constant returns to scale, the indivisibilities will tend to lead to increasing returns to scale.
What is the operating law of increasing returns to scale?
Increasing Returns to Scale: When the change in output is more than in proportion to the equi-proportional change in all the factors of production, then the operating law is called the increasing returns to scale. Thus, the rate of increase in output is faster than the increase in factors ...
What happens when the scale of production is increased?
When the scale of production is increased the division of labour and specialisation is introduced. A process of production is divided into sub-processes and each process is completed by each group of workers and at the same time the specialist are appointed for different departments, viz., finance manager, marketing manager, personnel manager, purchasing manager and so on and so forth. Their services lead to increase in the production and the increasing returns to scale operates.
What is the term for changes in output on account of the change in the factors of production in the same proportion?
The changes in output on account of the change in the factors of production in the same proportion are called the returns to scale. In the long run all the factors of production are variable and even the scale of production can be changed according to the demand for various goods and services in the economy. The returns to scale are concerned with long run production function. They are studied with the help of iso-product curves and iso-cost curves.
How to find the distance between iso-product curves?
The distance between iso-product curves is indicated by E, E 1, E 2 and E 3. The distance on scale line (OP) are equal. OE = EE 1 = E 1 E 2 = E 2 E 3. The distance between all iso-product curves remains constant which reveal that the production increases in the same proportion in which inputs are changed.
When the scale of production is increased and some of the scarce inputs are exploited to unlimited extent, what is?
When the scale of production is increased and some of the scarce inputs are exploited to unlimited extent the increase in output is less in proportion to change in all inputs during long period and diminishing return to scale operates.
When the scale of production is increased, what happens to the internal and external diseconomies of scale?
On account of these diseconomies the output increases less than in proportion to the change in the inputs and the diminishing returns to scale operates.
When proportionate change in output is less than the proportionate change in all the factors of production?
When proportionate change in output is less than the proportionate change in all the factors of production their (inputs) ratio being equal, the diminishing returns to scale will operate. The distance between various iso-product curves on the scale line increases because for getting the same level of output we have to employ more of all inputs.
Meaning of Production Function
Law of Returns to Scale
- In the long run, the dichotomy between fixed factor and variable factor ceases. In other words, in the long run, all factors are variable. The law of returns to scale examines the relationship between output and the scale of inputs in the long run when all the inputs are increased in the same proportion. Assumptions This law is based on the followi...
Table 1: Returns to Scale
- The data of table 1 can be represented in the form of figure 1 RS = Returns to scale curve RP = Segment; increasing returns to scale PQ = segment; constant returns to scale QS = segment; decreasing returns to scale Increasing Returns to Scale In figure 1, stage I represents increasing returns to scale. During this stage, the firm enjoys various internal and external economies such …
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