Laws of Returns to Scale

Production is a crucial economic activity because it improves the utility of a product by transforming it into the form required by the consumer. Leather, for example, is less commonly utilised in its raw state until it is converted into attractive products such as shoes, bags, and other accessories. To an economist, production refers to any process that transforms one or more commodities into another. The link between a firm’s outputs and inputs is the production function. Production refers to the transformation of inputs into outputs. The rate at which output changes when all inputs are adjusted simultaneously is referred to as returns to scale. Returns to scale is a metric that evaluates the change in productivity after increasing all production inputs over time.

The law of Return to Scale in Production Functions

Changes in output when all factors change in the same proportion are referred to as the law of return to scale. This law applies only in the long run when no factor is fixed, and all factors are increased in the same proportion to boost production.

There are three stages in all.

• Increasing the scale’s return
• Constant scale returns
• Decrease in Returns on the scale

Increasing returns to scale

It describes a condition in which all of the factors of production are raised, resulting in a higher rate of output. For example, if inputs are raised by 10%, the output will be increased by 20%.

 Reasons

•  Due to the economy of scale
•  Specialisation through better division of labour

Constant returns to scale

It describes a condition in which all of the factors of production are increased at the same time, resulting in a steady growth in output. For example, if inputs are raised by 10%, the output is also increased by 10%.

Reasons

As the firm’s production grows, it reaches a point where all of the economy’s resources have been fully utilised, and output equals input.

Diminishing returns to scale

When all of the production factors are increased simultaneously, output grows at a slower rate. For example, if inputs are raised by 10%, the output will be increased by 5%.

Reasons

• The major cause of diminishing returns to scale is large-scale economies, diseconomies of scale occur when a company has grown to such a size that it is difficult to manage
• Lack of coordination

Assumptions of Return to scale

The following are the returns to scale assumptions: Capital and labour are the only two variables of production used by the company. In a fixed proportion, labour and capital are integrated. Factor prices do not fluctuate, and the State of technology remains the same.

Difference between return to scale and return to a factor

• Return to factor has only one variable while the rest of the factors remain constant, whereas return to scale has all of the variables changing
• In return for factor, the factor proportion changes as more and more variable factor units raise production
• In return to scale, the factor proportion remains constant when factors are re-added in the same proportion to increase output
• When you return to a factor, you get a negative return. Returning to scale has the effect of decreasing returns
• Return to scale is a long-term phenomenon, whereas return to a factor is a one-time event

Difference between variable factor and fixed factor

• Variable factors can be modified in the short run, whereas fixed factors cannot be changed in the short run
• Variable factors fluctuate immediately with output, whereas fixed factors do not vary directly with output
• Variable factors include raw materials, casual labour, power, and fuel, whereas fixed factors include expenses related to buildings, plant and machinery, components, etc

What do you mean by short run and long run?

In the short run, the output can be modified by altering only variable factors, whereas, in the long run, the output may be changed by changing all production factors. In the long run, all factors are changeable. However, the production factors are increased simultaneously. Demand is active in price determination in the short run since supply cannot be raised quickly with a rise in demand. However, in the long run, both demand and supply play equal roles in the determination of price because both may be increased.

Conclusion

Return to scale is a metric that evaluates the change in productivity after increasing all production inputs over time.  The rate at which output changes when all inputs are adjusted simultaneously is referred to as returns to scale.

Return to scale is important to study as it is a metric in economics that is used to measure its efficiency. A company’s production is efficient if it can maintain its current output while utilising fewer inputs or resources or increase output while using the same amount of input.