Question

Elucidate the Laws of Returns to Scale. Illustrate.

Answer 1

In the long run, all factors are variable. The laws of returns to scale explain the relationship between output and the scale of inputs in the long run when all the inputs are increased in the same proportion.
Assumptions:

1. All the factors are variable except the organization.
2. There is no change in technology.
3. There is perfect competition in the market.
4. Outputs or returns are increased in physical quantities.

Three phases of returns to scale:

• Increasing returns to scale:
  If all inputs are increased by one percent, output increase by more than one percent.
• Constant returns to scale:
  In this case, if all inputs are increased by one percent, output increases by one percent.

Diagrammatic Illustration:

Stages	Input	Output	Returns to Scale
a to b	100% ↑	200% ↑	Increasing
b to c	100% ↑	100% ↑	Constant
c to d	100% ↑	33.33% ↑	Decreasing

In the diagram, the movement from point a to point b represents increasing returns to scale. Between these two points, input has doubled but the output was tripled.
The law of constant returns is implied by the movement from point b to point c. Between these two points inputs have doubled and output also has doubled.
Decreasing returns to scale are denoted by the movement from point c to point d since doubling the factors from 4 units to 8 units produces less than the increase in inputs, that is by only 33.33%.