Page 174 - DECO401_MICROECONOMIC_THEORY_ENGLISH

Unit-8: Production Function and Law of Production

The main reason of increasing returns to scale is it gives opportunity to economies cost like division Notes
of labour and specialization of work. Due to this, this return gives more production than the use of
production factors. Savings are internal because it only relates to the size of the firm.

(ii) Constant Returns to Scale

Constant returns to scale occurs when a given percentage increase in all factor inputs (in some
constant ratio) causes equal percentage increase in output. According to this law, suppose there is an
increment of labour and capital by 10%, then the production will rise by 10%.
In Fig. 8.7, OQ curve indicates constant returns to scale. The figure shows that the production percentage
is up by 10% by increasing 10% to all the percentage of factors. Thus the production percentage
increases by 20% if 20% increase in the parentage of production factors. This clarifies that the production
percentage increases if the ratio of production factor increases. So, the OQ line shows constant returns
to scale by making 45 degree angle to point O.

Fig. 8.7

Y
Constant returns Q
25
to scale
% Increase in output 20

15

10
5
O x
5 10 15 20 25
% Increase in all factor inputs
(Factor ratio remaining constant)

To use this law in a fixed stage of production, the profit and loss are equal to each other. This is known
as Homogenous Production Function in terms of mathematical representation. In this function, if
labour and capital are increasing by a ratio, then the production percentage would be increased by
that ratio.

(iii) Diminishing Returns to Scale

Diminishing returns to scale occurs when given percentage increase in all factor inputs (in some
constant ratio) causes proportionately less increase in output.
If the production is decreasing 10% by increasing 15% to its factors, it is called Diminishing Returns
to Scale. Figure 8.8 indicates the diminishing returns to scale. OQ line indicates that the production is
increasing 10% by increasing 15% of the factors and it increases 15% by increasing 25% of the factors.
This indicates the decreasing of diminishing returns to scale.

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