Law of Returns to Scale

By Mrs. N. Jayaprada

The Law Of Returns To Scale Production Function All variable inputs

The laws of returns to scale explain the behavior of

output in response to a proportional and simultaneous change in inputs. Increasing inputs proportionately and simultaneously is, in fact, an expansion of the scale of production. All inputs are changed in the same proportion.

Definition: It refers to the degree by

which the level of output changes in response to a given change in all the

Possibility of outcomes
Total output may increase more than proportionately

Total output may increase equally proportionately

Total output may increase less than proportionately

Accordingly, there are three kinds of return to scale Increasing returns to scale Constant returns to Scale Decreasing returns to scale

Returns to Scale in Silicon Factory

Units of Land (in acres) Units of labour (No. ) Units of capital (in lakhs) % increase in labour & land capital Total product % increase in total product Returns to scale

1 2 3 4 5 6 7 8 9

10 20 30 40 50 60 70 80 90

100 200 300 400 500 600 700 800 900

100 50 33.33 25 20 16.66 14.29 12.5

100 220 350 500 625 750 860 940 1000

120 59 42.9 25 20 14.66 9.3 6.4

Increasing

Constant

Decreasin g

Increasing Returns to Scale

When the proportionate increase in output is greater than proportionate increase in all inputs. Economies of Scale The Causes Technical and managerial indivisibilities Higher degree of specialization Dimensional relations Division of labour

Constant Returns to Scale

When the proportionate increase in output is

equally proportionate increase in input.

The Causes limits of the economies of scale. With expansion in the scale of production, economies arise from such factors as indivisibility of fixed factors, greater possibility of specialization of capital and labor, use of labor saving techniques of production, etc. are limited up to a level

Decreasing Returns to Scale

When the proportionate increase in output is

less

than proportionate increase in all inputs.

Diseconomies of scale

The causes Diseconomies of scale. The most important factor causing this is the diminishing return to management. Another factor is the exhaustibility of natural resources.

Economies of Scale
Internal Economies Economies of increasing plant size.
REAL ECONOMIES
Managerial Economies Specialisation of management Decentralisation Teamwork experience Modern managerial and organisational techniques. Marketing Economies Advertising economies Exclusive dealers with after-sale service obligations

Economies of Scale
Production Economies Labour Division of labour Cumulative volume economies (experience curve) Technical Specialisation of capital equipment Indivisibilities (minimum sizes or definite ranges) The economies of large machines multipurpose and general purpose machines. Inventory economies Transport and Storage Economies

Pecuniary Economies
Savings in expenses because of bulk buying and selling
Bulk buying of materials Lower cost of capital Advertising at large scale at lower rate Less per unit rate of transportation Lower wages and salaries because of prestige of

the firm.

External Economies
Outside the firm, from improvement of the

environment in which the firm operates. Combined R&D Expansion of Industry Specialised firms for By-products and waste materials

Diseconomies of Scale
Average cost of production increases

Technical inefficiencies
Human and behavioural problems red tapism

personal touch

control loss Management problems improper supervision, regulation

Queries???

Thank Q