Two Variable Law of Returns to Scale Assignment Help

Two Variable Law of Returns to Scale Assignment Help
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Two Variable Law of Returns to Scale Assignment Help

In the long run, all the factors of production turn out to be variable; therefore, no factor is fixed. So, the scale of production too can be altered through an alteration in the amount of every factor of production. This topic has got a huge significance to the students of economics, and so, they get involved in the process of studying it.

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Three Types of Return to Scale

The three possible kinds of returns to scale are:

  • Increasing returns to scale
  • Constant returns to scale
  • Diminishing returns to scale

When output gets intensified by the same proportional alteration as every input changes, then there is CRS (constant returns to scale).

When output increases lesser than a proportional alteration in all inputs, then there is DRS (decreasing returns to scale).

When output intensifies by more than the proportional alteration in all inputs, then there happens IRS (increasing returns to scale).

Commonly, the production of a firm is capable of exhibiting various types of returns to scale in various ranges of output. Commonly, there can be increasing returns at comparatively low output levels, constant returns at an output level between two ranges and decreasing returns at comparatively high output levels.

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Reasons that Give Rise to Increasing Returns

Law of increasing returns does apply due to the following reasons:

  • Indivisibility of factors of production – This is one of the chief reasons which result in intensification in the law of increasing returns.
  • Division of labor – The law of increasing returns does operate due to a division of specialization and labor.
  • Internal and external economies – Internal and external economies related to marketing, finance, production, and organization are hugely helpful in lessening the cost of production as well as augmenting the amount of production.

Why does the Law Operate in the Industry?

The main reasons for the law of increasing returns are as follows:

  • Elastic supply – Commonly, factors of production in the manufacturing industry have elastic supply. By this, it is meant, demand for every factor can be intensified whenever needed.
  • Economies of huge scale – When more and more units of flexible factors are employed, the productivity of both these factors gets increased. Because of these economies, total cost/unit falls when the total product does increase at an increasing rate.
  • More utilization of machinery – The reasons for the operation of this law in the manufacturing industry is there is more utilization of machinery compared to in the agricultural sector and the use of machinery lessens the cost/unit.
  • Division of labor – There is a huge possibility of division of labor in the manufacturing industry. Production becomes more compared to the proportional augmentation in factors, and so, cost/unit continues to decrease.
  • Less influence of nature – In the manufacturing sector, the nature tends to be softer compared to the agricultural sector and winter, summer, and rain have no effect on industries.

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Examples of Returns to Scale

When the use of all inputs gets increased by 2, then new values for output becomes:

  • Twice the earlier output when there is CRS (constant returns to scale).
  • More than twice the earlier output when there is IRS (increasing returns to scale).
  • Less than twice the earlier output when there is DRS (decreasing returns to scale).

If it is assumed that all the factor costs are constant and the production function is homothetic, a firm which experiences constant returns will have constant long-run average costs, a firm that experiences decreasing returns will have intensifying long-run average costs. Again, a firm that experiences increasing returns will have decreasing long-run average costs.

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