Page 113 - DECO101_MICRO_ECONOMICS_ENGLISH

Micro Economics

Notes the ROCE of Grasim and Coats Viyella (India) fell by almost 2 per cent per annum. Even in
absolute returns on assets or on capital employed, Indian companies fare a lot worse. While
Indian textile companies just about cover their WACC, their international rivals earn about
8 per cent in excess of their cost of capital.
Questions
1. Is Indian companies running a risk by not giving attention to cost cutting?
2. Discuss whether Indian Consumer goods industry is growing at the cost of future
profi tability.
3. Discuss capital and labour productivity in engineering context and pharmaceutical
industries in India.

4. Is textile industry in India performing better than its global competitors?

8.2 Law of Returns to Scale (Long Run)

If all inputs are changed at the same time (possible only in the long run), and suppose are increased
proportionately, then the concept of returns to scale has to be used to understand the behaviour
of output. The behaviour of output is studied when all factors of production are changed in the
same direction and proportion.
In the long run, output can be increased by increasing the ‘scale of operations’. When we speak
of increasing the ‘scale of operations’ we mean increasing all the factors at the same time and by
the same proportion.

Example: In a factory, in the long run, the scale of operations may be increased by
doubling the inputs of labour and capital. The laws that govern the scale of operation are called
the laws of returns of scale.
!

Caution The laws of returns to scale always refer to the long run because only in the long
run are all the factors of production variable. In other words, only in the long run is it pos-
sible to change all the factors of production. Thus the laws of returns to scale refer to that
time in the future when changes in output are brought about by increasing all inputs at the
same time and in same proportion.
Returns to scale are classified as follows:

1. Increasing Returns to Scale (IRS): If output increases more than proportionate to the
increase in all inputs.
2. Constant Returns to Scale (CRS): If all inputs are increased by some proportion, output
will also increase by the same proportion.
3. Decreasing Returns to Scale (DRS): If increase in output is less than proportionate to the
increase in all inputs.
For example, if all factors of production are doubled and output increases by more than two
times, then the situation is of increasing returns to scale. On the other hand, if output does not
double even after a cent per cent increase in input factors, we have diminishing returns to scale.
The general production function is
Q = f (L, K)

If land, K, and labour, L, is multiplied by h and Q increases by λ, we get,
λQ = f(hL, hK)

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