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:Increasing returns to scale:-
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.
Constant returns to scale:-
Total inputs |
Total output/product |
1L+1K |
5 |
2K+2L |
10 |
4K+4L |
20 |
Decreasing returns to scale:-
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.
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