For undergraduate agricultural students of the course ‘Ag. Econ. 6.4 Farm Management, Production, and Resource Economics (2+1)’ of Junagadh Agricultural University, Gujarat and other State Agricultural Universities in India.

1. Lecture 07: Returns to Scale
1

2. Law of returns to scale
• The laws of returns to scale explain the behavior of
output in response to a proportional and
simultaneous change in all the inputs.
• Assumption: All the inputs change in same
proportions.
2

3. 3

4. Concept:
4/23/2020 4
P = f (L, K)
Suppose the production function is as follows:
Now, if both the factors of production i.e., labour and capital are increased in
same proportion i.e., x, product function will be rewritten as:

5. Assumptions
• All the factors of production (such as land, labor and
capital) but organization are variable
• The law assumes constant technological state. It
means that there is no change in technology during
the time considered
• The market is perfectly competitive
• Outputs or returns are measured in physical terms.
5

6. Types of Returns to Scale
When a firm increases all the inputs in the same proportion,
then there are three possibilities:
1. Total output may increase more than proportionately
2. Total output may increase proportionately
3. Total output may increase less than proportionately
Accordingly, there are three kinds of return to scale
1. Increasing returns to scale
2. Constant returns To Scale
3. Decreasing returns to scale
6

7. Unit Scale of Production
Total
Returns
Marginal Returns Stage
1
1 Labor + 2 Acres of
Land
4 4
(Stage I - Increasing
Returns)
2
2 Labor + 4 Acres of
Land
10 6
3
3 Labor + 6 Acres of
Land
18 8
4
4 Labor + 8 Acres of
Land
28 10
(Stage II - Constant
Returns)
5
5 Labor + 10 Acres
of Land
38 10
6
6 Labor + 12 Acres
of Land
48 10
7
7 Labor + 14 Acres
of Land
56 8
(Stage III -
Decreasing Returns)
8
8 Labor + 16 Acres
of Land
62 6
A hypothetical example of returns to scale:
7

8. 8
Returns to Scale: Diagrammatic representation

9. I Stage: Increasing returns to scale
• The firms are faced with increasing returns to scale
when a certain proportionate change in inputs,
lead to more than proportionate change in output.
Causes:
1. Division of labour
2. Higher degree of specialization
3. External economies of scale
9
Note: Economies of scale are the cost advantages that enterprises
obtain due to their scale of operation, with cost per unit of output
decreasing with increasing scale. E.g. Think of a hotel business
 more the customers, lesser will be per unit operating cost.

10. II Stage: Constant returns to scale:
• When the change in output is proportional to the
change in inputs, it exhibits constant returns to
scale. # Changes in output and input are same.
• Economies of scale is balanced by diseconomies of
scale.
• This is also known as
homogeneous
production function.
10
Diseconomies of scale represent the
situation where the marginal cost or long run
average cost per unit of output produced
increases with increase in production due to
internal and external factors.

11. Decreasing returns to scale:
• The firms are faced with decreasing returns to scale
when a certain proportionate change in inputs, lead
to less than proportionate change in output.
• It means, if inputs are doubled, output will be less
than doubled.
• If 20 percent increase in labour and capital is
followed by 10 percent increase in output, then it is
an instance of diminishing returns to scale.
11

12. Causes of Diminishing return to scale
12
• Limited resources
• Decrease in managerial efficiency (as firm size expands)

13. Difference between the law of Returns
and Law of Returns to Scale
Law of Variable Proportions
• Applicable in short period
• Only one factor is varied
• The factor ratio remains
changed
• There are three stages:
a) Increasing returns to a
factor
b) Decreasing returns to a
factor
c) Constant returns to a
factor
Returns to Scale
• Applicable in long period
• All factors varied
• The factor ratio remains
unchanged
• There are three stages:
a) Increasing returns to
scale
b) Decreasing returns to
scale
c) Constant returns to
scale
13