The Law of Returns to Scale

The law of returns are often confused with the law of returns to scale. The law of diminishing returns operates in the short period. It explains the production behaviour of the firm with one factor variable while other factors are kept constant. Whereas the laws of returns to scale operates in the long period. It explains the production behaviour of the firm under the conditions when both the inputs (labour and capital) are variable and they can be increased proportionately and simultaneously.

It has been observed that when there is a proportionate change in the amounts of. inputs, the behaviour of output varies. The output may increase by a great proportion, by in the same proportion or in a smaller proportion to its inputs. This behaviour of output with the increase in scale of operation is termed as increasing returns to scale, constant returns to scale and diminishing returns to scale. These three laws of returns to scale are now explained, in brief, under separate heads.

(1) Increasing returns to scale:

Increasing returns to scale means that   Capital
output increases in a greater proportion per week than the increase in inputs. For example, if the amounts of input are doubled and the output increases by more than double, it is said to be an increasing returns to scale.

(i) Advantages of division of labour

(ii) Specialization in production process.

(iii) Use of specialized machines which enable output to grow faster.

(iv) Economies of scale which reduces average cost per unit.

Increasing returns to scale

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