Introduction
The law of variable proportion analyses the behaviour of output
when one input factor is variable and the other factors are held constant. Thus
it is a short run analysis. But in the long run all factors are variable. When
all factors are changed in same proportion, the behaviour of output is analysed
with laws of returns to scale. Thus law of returns to scale is a long run
analysis. In the long period, output can be increased by varying all the input
Factors this law is concerned, not with the proportions between the factors of
production, but with the scale of production. The scale of production of the
firm is determined by those input factors which cannot be changed in the short
period. The term return to scale means the changes in output as all factors change
in the same proportion. The law of returns to scale seeks to analyse the
effects of scale on the level of output. If the firm increases the units of
both factors labour and capital, its scale of production increases. The return
to scale may be increasing, constant or diminishing.
Increasing
Returns to Scale
When inputs are increased in a given proportion and output
increases in a greater proportion, the returns to scale
are said to be increasing. In other words, proportionate increase in all factors of
production results in a more than proportionate increase in output It is a case of
increasing returns to scale.
For example, if the inputs are increased by
40% and output increased by 50%, return to scale are increasing (= >1). It
is the first stage of production.
If the industry is enjoying increasing returns, then its marginal
product increases. As the output expands, marginal costs come
down. The price of the product also comes down.
Constant
Return to Scale
When inputs are increased in a given proportion and output
increases in the same proportion, constant return to
scale is said to prevail. For example, if inputs are increased by
40% and output also increases by 40%, the return to scale are said to be
constant ( = 1). This may be called homogeneous production function of the
first degree. In case of constant returns to scale the average output
remains constant. Constant returns to scale operate when the
economies of the large scale production balance with the diseconomies.
Decreasing
Returns to Sale
Decreasing returns to scale is otherwise known as the law of
diminishing returns. This is an important law of production. If the firm continues to
expand beyond the stage of constant returns, the stage of diminishing returns to
scale will start operate. A proportionate increase in all inputs results
in less than proportionate increase in output, the returns to scale is said to
be
decreasing. For example, if inputs are increased by 40%, but output
increases by only 30%, ( = < 1), it is a case of decreasing return to scale.
Decreasing return to scale implies increasing costs to scale.
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