Assignment

Q6.Explain the law of returns to scale.

Ans: The laws of returns to scale are often confused with ‘returns to scale’. By “returns to scale” is meant the behavior of production or returns when all productive factors are increased or decreased simultaneously and in the same ratio. When all inputs are changed in the same proportion, we call this as a change in scale of production. The way total output changes due to change in the scale of production is known as returns to scale. Thus, whereas in the short-run change in output is associated with the change in factor proportions, and change in output in the long-run is associated with change in the scale of production. Thus returns to scale is the long-run concept. A layman would perhaps expect that with doubling of all productive factors, the output will also double and with trebling of factors of production, production would also be trebled, and so on. But actually this is not so. In other words, when all inputs are increased in the same proportion, the total product may increase at an increasing rate, are a constant rate or diminishing rate. Accordingly the returns to scale could be ‘increasing, ‘constant’, or ‘decreasing’. And 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

* 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.

* Outputs or returns are measured in physical terms.

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...