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CH 7 Eco

This document discusses returns to scale in production functions. It defines total product, marginal product, and average product. It then explains the three types of returns to scale: increasing, constant, and diminishing returns. Increasing returns occur when a 10% increase in inputs leads to more than a 10% increase in outputs. Constant returns occur when a 10% increase in inputs leads to a 10% increase in outputs. Diminishing returns occur when a 10% increase in inputs leads to less than a 10% increase in outputs. The document also discusses assumptions of returns to scale and differences between variable and fixed factors.

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46 views

CH 7 Eco

This document discusses returns to scale in production functions. It defines total product, marginal product, and average product. It then explains the three types of returns to scale: increasing, constant, and diminishing returns. Increasing returns occur when a 10% increase in inputs leads to more than a 10% increase in outputs. Constant returns occur when a 10% increase in inputs leads to a 10% increase in outputs. Diminishing returns occur when a 10% increase in inputs leads to less than a 10% increase in outputs. The document also discusses assumptions of returns to scale and differences between variable and fixed factors.

Uploaded by

sanchita kapoor
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 4

CHAPTER 7

LAWS OF RETURN-RETURNS TOA FACTOR AND RETURNS TO A SCALE

Total Product as the total volume or amount of final output produced by a firm using given
inputs in a given period of time.

Marginal Product

The additional output produced as a result of employing an additional unit of the variable factor
input is called the Marginal Product. Thus, we can say that marginal product is the addition to
Total Product when an extra factor input is used.
Marginal Product = Change in Output/ Change in Input

Average Product
It is defined as the output per unit of factor inputs or the average of the total product per unit of
input.
Average Product = Total Product/ Units of Variable Factor Input

The law of Return to Scale in Production Functions


Changes in output when all factors change in the same proportion are referred to as the law of
return to scale. This law applies only in the long run when no factor is fixed, and all factors
are increased in the same proportion to boost production.
There are three stages in all.
 Increasing the scale’s return
 Constant scale returns
 Decrease in Returns on the scale
Increasing returns to scale
It describes a condition in which all of the factors of production are raised, resulting in a
higher rate of output. For example, if inputs are raised by 10%, the output will be increased
by 20%.
 Reasons
  Due to the economy of scale
  Specialisation through better division of labour
Constant returns to scale
It describes a condition in which all of the factors of production are increased at the same
time, resulting in a steady growth in output. For example, if inputs are raised by 10%, the
output is also increased by 10%.
Reasons
As the firm’s production grows, it reaches a point where all of the economy’s resources have
been fully utilised, and output equals input.
Diminishing returns to scale
When all of the production factors are increased simultaneously, output grows at a slower
rate. For example, if inputs are raised by 10%, the output will be increased by 5%.
Reasons
 The major cause of diminishing returns to scale is large-scale economies,
diseconomies of scale occur when a company has grown to such a size that it is
difficult to manage
 Lack of coordination

Assumptions of Return to scale


The following are the returns to scale assumptions: Capital and labour are the only two
variables of production used by the company. In a fixed proportion, labour and capital are
integrated. Factor prices do not fluctuate, and the State of technology remains the same
Difference between variable factor and fixed factor
 Variable factors can be modified in the short run, whereas fixed factors cannot be
changed in the short run
 Variable factors fluctuate immediately with output, whereas fixed factors do not vary
directly with output
 Variable factors include raw materials, casual labour, power, and fuel, whereas fixed
factors include expenses related to buildings, plant and machinery, components, etc

What do you mean by short run and long run?


In the short run, the output can be modified by altering only variable factors, whereas, in the
long run, the output may be changed by changing all production factors. In the long run, all
factors are changeable. However, the production factors are increased simultaneously.
Demand is active in price determination in the short run since supply cannot be raised quickly
with a rise in demand. However, in the long run, both demand and supply play equal roles in
the determination of price because both may be increased.

Returns to a factor refers to the behaviour of physical output owing to change in physical input of a
variable factor, fixed factors remaining constant.
Assumptions of Law of Variable Proportions::
1. It operates in short run, as factors are classified as variable and fixed factor,
2. The law applies to all fixed factors including land.
3. Under law of variable proportions, different units of variable factor can be combined with fixed
factor.
3. This law applies to the field of production only.
4. The effect of change in output due to change in variable factor can be easily determined.
5. It is assumed that, factors of production become imperfect substitutes of each other beyond a
certain limit.
6. The state of technology is assumed to be constant during the operation of this law.
7. It is assumed that all variable factors are equally efficient.

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