Laws of Returns To Scale: In the long – run, there is no fixed factor; 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:
Laws of Returns to Scale are based on the following assumptions.
1. All the factors of production, [such as land, labour and capital] are variable but organization is fixed.
2. There is no change in technology.
3. There is perfect competition in the market.
4. Outputs or returns are measured in physical quantities.
Three Phases of Returns to Scale:
1. Increasing Returns to Scale: In this case if all inputs are increased by one percent, output increase by more than one percent.
2. Constant Returns to Scale: In this case if all inputs are increased by one percent, output increases exactly by one percent.
3. Diminishing Returns to Scale: In this case if all inputs are increased by one percent, output increases by less than one percent.
The three laws of returns to scale can be explained with the help of the diagram below.
Diagramatic Illustration:
In the figure, the movement from point a to point b represents increasing returns to scale. Because, between these two points output has doubled, but output has tripled. The law of constant returns to scale is implied by the movement from the point b to point c.
Because, between these two points inputs have doubled and output also has doubled. Decreasing returns to scale are denoted by the movement from the point c to point d since doubling the factors from 4 units to 8 units product less than the increase in inputs, that is by 33.33%.
