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Laws of Returns to Scale
The law of returns to scale shows the relationship between output and factors of production in the long run. In other words, the law of returns to scale is related to the long-run production function. Therefore, in this law, all factors of production are considered variable.
This law explains how output changes when all factors of production are changed in the same proportion. When all factors of production are changed in the same proportion, the following three situations arise:
(a) Increasing returns to scale
(b) Constant returns to scale
(c) Decreasing returns to scale
These different stages of production are explained as follows:
(a) Increasing Returns to Scale:
Increasing returns to scale occurs when the output increases by a larger proportion than the increase in the factors of production. In this situation of production, if the factors of production are doubled, the output increases by more than double, and if the factors of production are tripled, the output increases by more than triple. Therefore, in the situation of increasing returns to scale, the marginal productivity or marginal output of the factors of production also increases. This concept can be clarified from the following table and graph:
| Units of Labor and Capital | Total Production (in kg) | Marginal Production (in kg) |
|---|---|---|
| 1 | 10 | 10 |
| 2 | 25 | 15 |
| 3 | 45 | 20 |
Based on the above table, the following graph can be drawn:
In the graph above, the x-axis shows the quantity of labor and capital, and the y-axis shows the marginal production. The upward sloping curve MP represents the marginal production. It is clear from the above table and graph that as the quantity of labor and capital increases, the marginal production also increases, so the marginal production curve MP slopes upwards from left to right.
When the quantity of labor and capital is 1 unit, the marginal production is 10 kg. When the quantity of labor is increased to 2 units and 3 units, the marginal production increases to 15 kg and 20 kg, respectively. Therefore, in the situation of increasing returns to scale, the marginal production curve (MP) slopes upwards from left to right.
(b) Constant Returns to Scale:
Constant returns to scale occurs when the output increases by the same proportion as the increase in the factors of production. In this situation, if the factors of production are doubled, the output also doubles, and if the factors of production are tripled, the output also triples. Therefore, the marginal productivity or marginal output of the factors of production remains constant. This concept can be clarified from the following table and graph:
| Units of Labor and Capital | Total Production (in kg) | Marginal Production (in kg) |
|---|---|---|
| 1 | 10 | 10 |
| 2 | 20 | 10 |
| 3 | 30 | 10 |
Based on the above table, the following graph can be drawn:
In the graph above, the x-axis shows the quantity of labor and capital, and the y-axis shows the marginal production. The horizontal curve MP, parallel to the x-axis, represents the marginal production. Since the marginal production is 10 kg for every unit of labor and capital, the marginal production curve MP becomes a straight horizontal line.
Therefore, in the situation of constant returns to scale, the marginal production curve is a straight horizontal line parallel to the x-axis.
(c) Decreasing Returns to Scale:
Decreasing returns to scale occurs when the output increases by a smaller proportion than the increase
| Units of Labor and Capital | Total Production (in kg) | Marginal Production (in kg) |
|---|---|---|
| 1 | 10 | 10 |
| 2 | 18 | 8 |
| 3 | 24 | 6 |
Based on the above table, the following graph can be drawn:
In the graph above, the x-axis shows the quantity of labor and capital, and the y-axis shows the marginal production. The downward sloping curve MP represents the marginal production. It is clear from the above table and graph that as the quantity of labor and capital increases, the marginal production decreases, so the marginal production curve MP slopes downwards from left to right.
When the quantity of labor and capital is 1 unit, the marginal production is 10 kg. When the quantity of labor and capital is increased to 2 units and 3 units, the marginal production decreases to 8 kg and 6 kg, respectively. Therefore, in the situation of decreasing returns to scale, the marginal production curve slopes downwards from left to right.
Combined diagram for the Laws of Returns to Scale
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