Law of Returns to Scale

 In the long run, all factors of production are variable. No factor is fixed. Accordingly, the scale of production can be changed by changing the quantity of all factors of production.

Definition:

“The term returns to scale refers to the changes in output as all factors change by the same proportion.” Koutsoyiannis

Explanation:

In the long run, the output can be increased by increasing all factors in the same proportion. Generally, laws of returns to scale refer to an increase in output due to an increase in all factors in the same proportion. Such an increase is called returns to scale.

The above-stated table explains the following three stages of returns to scale:

1. Increasing Returns to Scale: Increasing returns to scale or diminishing cost refers to a situation when all factors of production are increased, output increases at a higher rate. It means if all inputs are doubled, the output will also increase at a faster rate than double. Hence, it is said to be increasing returns to scale.

2. Diminishing Returns to Scale: Diminishing returns or increasing costs refer to that production situation, where if all the factors of production are increased in a given proportion, output increases in a smaller proportion. It means, if inputs are doubled, the output will be less than doubled. If a 20 percent increase in labor and capital is followed by a 10 percent increase in output, then it is an instance of diminishing returns to scale.

3. Constant Returns to Scale: Constant returns to scale or constant cost refers to the production situation in which output increases exactly in the same proportion in which factors of production are increased. In simple terms, if factors of production are doubled output will also be doubled