Thursday, August 6, 2015

Types of returns to Scale

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Return to scale is the quantitative change in output of a firm or industry resulting from a proportionate increase in all inputs.
Increasing Return to scale:
Increasing Return to scale implies that output increases more than proportionately to the increase in input and the rate of increase in output goes on increasing with each subsequent increase in input.
For example, suppose inputs are increased by 50% & output increases by more than 50%, say by 75% and when inputs are again increased by 50%, output increased by 100% i.e. (75+25)% and so on.

Reason for Increasing Return to scale:
1. Indivisibility of factor of production:
When scale of production is increased by increasing all inputs, the productivity of indivisible factors increases exponentially. This results in increasing returns to scale.
2. Higher degree of specification:
The use of specified labour and management increases productivity per unit of inputs. So, return to scale increases.
3. Dimensional relation:
When the size of a bed (5', 2' = 10 sq ft) is doubled to 10', 4', the area is more than doubled to 10' × 4' = 40 sq ft. Like this, when labour & capital are doubled, the output is more than doubled.

Reason for constant return to scale:
It occurs when factors of production are perfectly divisible. When factors are perfectly divisible, the PF is homogeneous of degree 1.
Causes of diminishing return to scale:
It causes due to managerial diseconomies. The size of the firm expands, managerial efficiency decreases causing decrease in the rate of increase in output.

1. DU
2. Britannica

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