Law of Return to Scale
Returns to scale in the long-run concept of production theory. In the long-run concept of production theory. In long-run all the inputs are variable.
The change in the output due to the change in scale of production studies as returns to scale. The law is concerned with the question of how output responds to the change in the amounts of all the inputs together. The production function shows three types of relationship between inputs and output in the long run.
Assumptions:-
- All the factors are variable but the enterprise is fixed.
- No change in technology.
- Presence of perfect competition.
- Output can be measured in quantity.
The situations of the law of return to scale are explained below:-
- The Increasing return to scale– If the percentage or proportionate increase in output is greater than the percentage of proportionate change in the combination of inputs, it is called increasing returns to scale. If the AP and MP increase with the proportionate change in inputs, the IRS operates in production. Eg. If the inputs are increased by 10%, output increases by 20%.
2. The Constant return to scale- If the percentage or proportionate increase in output is just equal to the percentage proportionate increase in the combination of inputs, it is called as constant returns to scale. If the AP and MP remain constant with the proportionate change in inputs, CRS operates in production. Eg. If the inputs are increased by 10%, output increases by 10%.
3. The Decreasing returns to scale- If the percentage or proportionate increase in output is less than the percentage of proportionate change in the combination of inputs, it is called as decreasing returns to scale. If the AP and MP decrease with the proportionate change in inputs, DRS operates in production. Eg. If the inputs are increased by 20%, output increases by 10%.
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