Economics

Law of Returns To Scale : Increasing Constant Decreasing Returns To Scale

Law of Returns to scale

The law of variable proportions is an important law in Economics. It describes how production can be increased with a constant factor while changing the proportions of the remaining factors. On the other hand, if we increase the proportion of all the factors and combine them in the same proportion, we get increasing, constant and diminishing returns one after another. This is known as returns to scale and the law explains the fact is known as the Law of Returns To Scale.

In other words law of variable proportions refers to that quantity of output obtained by keeping one factor constant and other factors variable. Returns to scale refers to that quantity of output obtained due to a change in the proportion of all the inputs. Hence the law of variable proportions and the law of returns to scale are not the same. Another difference between the two is that law of variable proportions refers to the short run adjustment in the factors for securing maximum output. On the other hand law of returns to scale refers to the long run analysis as all factors are changeable in that period.

Law of Returns to scale:

If we vary all the factors without keeping constant any factor we get increasing returns, constant returns and diminishing returns to scale one after another. They are called “Returns to Scale . The causes for this are explained as below:

Causes Of Increasing Returns To Scale :

 Increasing returns to scale arise when the output obtained is more than proportionate to the increase in the quantity of inputs. The following are the causes for increasing returns to scale :

1) Indivisibility of factors : Some factors of production are indivisible in nature They are not available below a minimum size. For example, the  productive capacity of sugar plant is 50 tonnes a day. We can’t setup sugar plants below this production capacity. So if we want, to manufacture sugar, we have to install this minimum capacity plant. But, when demand is low this plant can’t make production below the minimum capacity.

Increasing returns to scale arise until the full capacity of plant is completely utilized. So production can be increased without any additional expenses. So production costs decrease due to the complete utilization of the productive capacity of a sugar plant.

2) Specialization: Specialization is another cause for the increasing returns to scale. It becomes easy to introduce specialization when the scale of production increased. When production is carried on small scale, less numbers of the labourers are required. Specialization leads to the employment of skilled and efficient labourers. This increases the efficiency of laboureres. Besides, specialization also makes it possible to install latest machinery. As a result, quality and quantity of output increases to a great extent and production costs remain low.

3) External economies: External economies are another reason for the application of increasing returns to scale. These economies refer to those benefits received by the firms in an industry due to the expansion of the latter. When industry expands; more transport, communication, banking and insurance facilities are provided. As a result, Costs of production become less.

4) Increase in dimension : we increase the dimensions of some factors. Production will be increased by several times. For example, if we double the radius of a water pipe, more water can be flown through it. Similarly the cost of constructing a double decker bus is less than that of two single decker buses. Thus, increase in dimensions reduces cost and leads to the law of increasing returns to scale.

Causes Of Constant Returns To Scale :

Increasing returns to scale is not a continuous phenomenon. Increase in the size of the firm, after a stage, leads to disadvantages. The forces that give rise to increasing returns get exhausted. The proportions of increase in factors and that in output remain equal. This is known as constant returns to scale.

Constant returns to scale arises after increasing returns to scale and before diminishing or decreasing returns to scale. When a firm is managing productive operations under constant returns to scale, its economies and dis-economies balance each other. Constant returns also indicate the dangers of diminishing returns if the firm continues its production further.

Causes Of Decreasing Returns To Scale :

Like increasing returns, constant returns is also a temporary phenomenon. When production is carried after a particular stage, the firm faces diminishing returns to scale. As a result the dis-economies out-weigh the economies of the firm, Prof. J.M. Clark gave an example regarding the diminishing returns. A farmer, for getting large scale economies, designed a plough three times long, three times wide and three times deep than the ordinary plough. He used six horses for pulling this new plough. To his surprise the plough did not move. It finally took 50 horses for pulling the new plough. So even though we increase the factors, after a stage, we get diminishing returns.

Causes Of Decreasing Returns To Scale :

The following are the causes of the diminishing or decreasing returns to scale :

1) The efficiency and productive capacity of indivisible factors become less due to their complete utilization.

2) The difficulty arises in the supervision, coordination and maintenance of the firm when production is carried on over and above a particular level.

3) Increase in the quantity of factor leads to diminishing returns.

4) Besides the above internal dis-economies, external dis-economies are also responsible for the diminishing returns to scale. Expansion of industry leads to several problems like labour scarcity, wage and rent hike etc. As a result production costs will increase. A single entrepreneur can’t maintain production Operations. It is a difficult task for him to supervise and manage the affairs of a large firm.

Due to the above causes, diminishing or decreasing returns to scale arises after a particular stage.

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