Page 114 - DECO101_MICRO_ECONOMICS_ENGLISH

Unit 8: Laws of Production

We have constant, increasing or decreasing returns to scale, respectively depending upon, Notes
whether λ = h, λ > h or λ < h.
For example, if all inputs are doubled, we have constant, increasing or decreasing returns to
scale, respectively, if output doubles, more than doubles or less than doubles.

The firm increases its inputs from 3 to 6 units (K, L) producing either double (point B), more than
double (point C) or less than double (point D) output (Q) as shown in Figure 8.2.
Figure 8.2: Returns to Scale

Increasing returns to scale arise because as the scale of operation increases, a greater division of
labour and specialization can take place and more specialised and productive machinery can
be used. Decreasing returns to scale arise primarily because as the scale of operation increases,
it becomes more difficult to manage the firm. In the real world, the forces for increasing or

decreasing returns to scale often operate side by side, with the former usually overpowering the
latter at small levels of output and the reverse occurring at very large levels of output.
If all the factors of production are increased in a particular proportion and the output increases
in exactly that proportion then the production function is said to exhibit CRS. Thus if labour and
capital are increased by 10% and the output also increases by 10% then the production function
is CRS.
If you look at Figure 8.3, to produce X units of output, L units of labour and K units of capital are
needed (point a). If labour and capital are now doubled (as is possible in the long run), so that
there are 2L units of labour and 2K units of capital, the output is exactly doubled i.e., equals 2X
(point b). Similarly, trebling input achieves treble the output and so on.

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