Law of Return To Scale Final

Law of Return
to Scale
PRESENTED BY: –
ASEEM BUKHARI:-92
UMAR SHAIKH:-90
ADNAN DHUNDWARE:-93
AYESHA KHAN:-61
KAIF KHAN:-106
INTRODUCTION
 The law of returns to scale explains the proportional
change in output with respect to proportional change in
inputs.
 In other words, the law of returns to scale states when
there are a proportionate change in the amounts of inputs,
the behavior of output also changes.
 The degree of change in output varies with change in the
amount of inputs. For example, an output may change by
a large proportion, same proportion, or small proportion
with respect to change in input.
 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.
On the basis of these possibilities, law of returns can be classified into three categories:
i. Increasing returns to scale
ii. Constant returns to scale
iii. Diminishing returns to scale
1. Increasing Returns to Scale:
 If the proportional change in the output of an

organization is greater than the proportional change in
inputs, the production is said to reflect increasing
returns to scale. For example, to produce a particular
product, if the quantity of inputs is doubled and the
increase in output is more than double, it is said to be
an increasing returns to scale. When there is an increase
in the scale of production, the average cost per unit
produced is lower. This is because at this stage an
organization enjoys high economies of scale.
In this figure, a movement from a to b indicates that the amount of input
is doubled. Now, the combination of inputs has reached to 2K+2L from
1K+1L. However, the output has Increased from 10 to 25 (150%
increase), which is more than double. Similarly, when input changes
from 2K-H2L to 3K + 3L, then output changes from 25 to 50(100%
increase), which is greater than change in input. This shows increasing
returns to scale.
 There a number of factors responsible for increasing returns to scale.
 Some of the factors are as follows:
 i. Technical and managerial indivisibility:
 Implies that there are certain inputs, such as machines and human resource, used for the
production process are available in a fixed amount. These inputs cannot be divided to suit
different level of production. For example, an organization cannot use the half of the turbine
for small scale of production.
 Similarly, the organization cannot use half of a manager to achieve small scale of production.
Due to this technical and managerial indivisibility, an organization needs to employ the
minimum quantity of machines and managers even in case the level of production is much less
than their capacity of producing output. Therefore, when there is increase in inputs, there is
exponential increase in the level of output.
 ii. Specialization:
 Implies that high degree of specialization of man and machinery helps in increasing the scale
of production. The use of specialized labor and machinery helps in increasing the productivity
of labor and capital per unit. This results in increasing returns to scale.
 iii. Concept of Dimensions:
 Refers to the relation of increasing returns to scale to the concept of dimensions. According to
the concept of dimensions, if the length and breadth of a room increases, then its area gets
more than doubled.
 For example, length of a room increases from 15 to 30 and breadth increases from 10 to 20.
This implies that length and breadth of room get doubled. In such a case, the area of room
increases from 150 (15*10) to 600 (30*20), which is more than doubled.
2. Constant Returns to Scale
 The production is said to generate constant returns

to scale when the proportionate change in input is
equal to the proportionate change in output. For
example, when inputs are doubled, so output
should also be doubled, then it is a case of constant
returns to scale.
In this figure, when there is a movement from a to b, it indicates that
input is doubled. Now, when the combination of inputs has reached to
2K+2L from IK+IL, then the output has increased from 10 to 20.
Similarly, when input changes from 2Kt2L to 3K + 3L, then output
changes from 20 to 30, which is equal to the change in input. This shows
constant returns to scale. In constant returns to scale, inputs are divisible
and production function is homogeneous.
3. Diminishing Returns to Scale
 Diminishing returns to scale refers to a situation

when the proportionate change in output is less
than the proportionate change in input. For
example, when capital and labor is doubled but the
output generated is less than doubled, the returns
to scale would be termed as diminishing returns to
scale.
For ex. - If 15 percent increase in all
factorinputs causes, say only 10percent
increasein output, it is a case of
diminishing returns to scale.
 Diminishing returns to scale is due to
diseconomies of scale, which arises because of the
managerial inefficiency. Generally, managerial
inefficiency takes place in large-scale
organizations. Another cause of diminishing
returns to scale is limited natural resources. For
example, a coal mining organization can increase
the number of mining plants, but cannot increase
output due to limited coal reserves.
Conclusion
 A constant returns to scale is when an increase in
input results in a proportional increase in output.
Increasing returns to scale is when the output
increases in a greater proportion than the
increase in input. Decreasing returns to scale is
when all production variables are increased by a
certain percentage resulting in a less-than-
proportional increase in output.

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Law of Return

 If the proportional change in the output of an

 The production is said to generate constant returns

 Diminishing returns to scale refers to a situation

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