Law of Returns To Scale: UGC NET Commerce Notes & Study Material

Production is a very important activity because it transforms the goods into such a form that it fulfills the needs of the consumer. All the factors of production, in the long run, are variable. So, the scale of production can be changed according to the changes in the quantity of all factors of production. The law of returns to scale is the proportionality change in the output due to the changes in the inputs. There are increasing, decreasing, and constant returns to scale. Raw materials of various kinds go through a production process, and then it is converted into good that attracts consumers. The law of returns to scale means that the output changes according to the changes in all the inputs. It is a factor that measures changes in productivity due to the change in call production inputs over time.

The law of returns to scale is a topic that holds utmost importance in the UGC NET Commerce exam. It is a part of the commerce paper 2 syllabus of the UGC NET exam. You can check the commerce syllabus.

In this article, we will learn about the following:

• What Is the Law of Returns To Scale
• Returns To Scale Graph
• The Types of Returns To Scale
• Assumptions of Return to Scale
• Meaning of Short Run and Long Run
• Difference Between Return to Scale and Return to a Factor

What is the Law of Returns to Scale?

The ‘Law of Returns to Scale’, is an economic concept that describes how the production of a company will change when all resources employed to produce goods are augmented by the same proportion. For instance, if a factory doubles the number of machines and employees, how much extra will it produce? At the initial stage, if a firm raises its resources, its output (or production) will also go up at an accelerating rate. This is referred to as ‘increasing returns to scale’. Beyond a point, though, increasing more resources does not result in greater marginal growth in production, and it might even deteriorate. This is referred to as ‘decreasing returns to scale’. There is also a point in between where output grows at the same rate as the resources, known as ‘constant returns to scale’. The law assists companies in knowing how to expand effectively and when they should cease to expand resources.

Returns to Scale Graph

A ‘Returns to Scale graph’, illustrates how the production of a company varies when all resources are increased by the same proportion. It informs us about whether more resources result in more, less, or the same level of production.

Returns to scale describe how a company's production varies when all the inputs, such as land, labor, and capital, are added in larger amounts. There are three stages of returns to scale: increasing returns to scale, constant returns to scale, and decreasing returns to scale. These three stages enable firms to know how increased production impacts their output and efficiency.

Increasing Returns to Scale (IRS)

During the phase of increasing returns to scale, as a firm expands all inputs, it expands output at an escalating rate. This is due to the fact that firms make the most of resources, incurring reduced costs and increased productivity. For instance, if a plant doubles its labour and equipment but its output increases more than twice as much, it is facing increasing returns to scale. This tends to happen during the initial period of business growth when technology and specialization enhance productivity. Firms gain the maximum during this period as they have more output for the same amount of inputs.

Constant Returns to Scale (CRS)

In the phase of constant returns to scale, a rise in all inputs gives rise to the same proportionate increase in output. That implies that if a business doubles both its machines and employees, so does its output. Companies in this phase are at an optimum level of production such that they are not achieving additional benefits but neither are they suffering from inefficiencies. A case in point is a bakery that doubles both ingredients, ovens, and employees but also outputs precisely double the number of cakes. The bakery is witnessing constant returns to scale. This phase is typical when a company has utilized all of its resources and keeps producing at a constant rate. 

Decreasing Returns to Scale (DRS)

For the phase of decreasing returns to scale, when a firm expands all inputs, the production increases at a decreasing pace. This is because there are too many workers or machines which could result in inefficiencies, crowding, or even mismanagement. For instance, if a factory doubles its machines and workers but production rises by just 50%, it is facing diminishing returns to scale. This usually occurs when a firm is too big to be efficiently managed, resulting in increased costs and reduced productivity. Firms at this phase might have to enhance their technology or organization to prevent waste and inefficiencies. 

Assumptions of Return to Scale

The returns to scale assumptions describe the circumstances under which a company can have increasing, constant, or diminishing returns. The assumptions tell us how a firm can expand and whether its output will rise, remain unchanged, or fall.

All Resources Grow Proportionately

If the law of returns to scale is to hold, then the firm must increase all of its resources, such as employees, equipment, and materials, equally. If some resource is growing at a rate higher than others, then outcomes may not trend the same. This assumption serves to ensure the firm is growing in a symmetric manner. By raising everything proportionally, the firm can observe how it impacts production. This indicates whether the firm is becoming more efficient or not.

Technology Remains the Same

Another assumption is that the technology employed by the business remains the same as the resources are being increased. It implies that the company does not alter its machinery or equipment when it is growing. If the new technology is implemented, then it may have an impact on the usage of the resources. The concern here is only increasing the quantity of resources without modifying the usage. This assists in understanding the real effect of resources being increased on production.

No Change in Management

It is also presumed that the leadership or management of the business remains constant while resources are being added. If the management is changed, it may influence how effectively the resources are utilized. A good manager ensures that the business develops smoothly. This presumption makes sure that any production changes are only due to the added resources, not a shift in leadership. It helps keep the results of growth accurate.

Short-Term Orientation

The returns to scale law tends to assume that the company is interested in the short term. Businesses can observe directly in the short term how a rise in resources impacts production. Long-term implications can differ with new variables such as market conditions or competition entering the picture. This assumption simplifies the examination of returns to scale. It enables companies to strategize growth in the immediate future.

No External Changes

Lastly, the assumption is that there are no external factors influencing the business, such as changes in the economy or legislation. If external factors change, they may impact the way the business expands. This assumption maintains the emphasis on the internal changes of the business. It allows businesses to know how their own activities influence production. This makes the analysis of returns to scale more precise and targeted.

The short run and long run are economic terms referring to the period of time covered by firms and production. For the short run, it is true that some inputs, such as machinery and buildings, cannot be modified, but other inputs, including labor, can. What this implies is that firms can add workers or extend the number of working hours but not immediately increase their plants' capacity. In the long run, any factor of production, such as land, labor, and capital, can be modified. Firms can construct new factories, make new technology investments, or fundamentally alter their method of production. For expenses, the short run enjoys fixed and variable costs, whereas in the long run, all expenses are variable and firms can completely adapt to shifts in demand.

Conclusion

Law of returns to scale generally evaluate the productivity and efficiency of the firm after the changes in the input level. In the returns to scale, the changes in the output are typically adjusted according to the changes in the inputs. A company is said to be efficient when it produces more levels of output by using the same or less level of input as the company needs to cooperate and maintain the levels of returns to scale as per the requirement of the situation.

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Major Takeaways for UGC NET Aspirants What Is the Law of Returns to Scale: The law of returns to scale describes how a company's output will vary when all inputs, such as labor and machines, are multiplied. It assists businesses in determining whether increasing production will make them more productive or result in wastage. Returns to Scale Graph: A returns to scale graph illustrates the correspondence between increases in inputs and changes in output. It enables companies to observe whether they are receiving more, the same, or less output when they raise all inputs simultaneously. The Types of Returns to Scale: There are three returns to scale: increasing returns to scale (greater output), constant returns to scale (same output), and decreasing returns to scale (less output). These three types inform firms how effectively they utilize resources whenever they expand. Assumptions of Returns to Scale: The returns to scale assumptions are that every input increases by the same proportion, technology doesn't change, and firms have constant returns to scale. They assist in understanding how production behavior varies as companies increase. Meaning of Short Run and Long Run: The short run is a time when certain resources, such as machines, cannot be altered, but labor can be varied. The long run is a time when companies can alter all resources, such as constructing new factories or purchasing additional equipment. Difference Between Returns to Scale and Returns to a Factor: Returns to scale happen when all inputs change together, affecting overall production. Returns to a factor occur when only one input, like labor or machines, is changed while keeping others the same.

Law of Returns to Scale Previous Year Questions

1. Increasing returns to scale arise because as the scale of operation increases it causes-

Options. A. more division of labour and specialisation

1. production utilisation of machinery
2. lower procurement and logistics costs
3. more difficulties in managing form efficiently
4. more economies in advertising 

Choose the correct answer from the options given below:

1. A, B and C only
2. C, D and E only
3. A, B, C and D only
4. A, B, C and E only

Ans. d. A, B, C and E only