The Law Of Returns To Scale - Presentation Transcript

1. 2. The Law Of Returns To Scale The Laws Of Returns To Scale

The laws of returns to scale explain the behavior of output in response to a proportional and simultaneous change in inputs. Increasing inputs proportionately and simultaneously is, in fact, an expansion of the scale of production.

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When a firm increases both the inputs proportionately, there are three possibilities Total output may increase more than proportionately Total output may increase proportionately Total output may increase less than proportionately Accordingly, there are three kinds of return to scale Increasing returns to scale Constant returns To Scale Decreasing returns to scale Increasing Returns to Scale The Causes of Increasing Returns To Scale

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Technical and managerial indivisibilities Higher degree of specialization Dimensional relations Constant returns to scale

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When the change in output is proportional to the change in inputs, it exhibits constant returns to scale. Constant returns to scale Constant returns to scale

The constant returns to scale are attributed to the limits of the economies of scale. With expansion in the scale of production, economies arise from such factors as indivisibility of fixed factors, greater possibility of specialization of capital and labor, use of labor saving techniques of production, etc.

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Decreasing returns to scale

10. Decreasing returns to scale

The firms are faced with decreasing returns to scale when a certain proportionate change in inputs, k & l, lead to less than proportionate change in output.

11. Causes of Diminishing return to scale

The decreasing returns to scale are attributed to the diseconomies of scale. The most important factor causing this is the diminishing return to management. Another factor is the exhaustibility of natural resources.

Marginal analysis implies judging the impact of a unit change in one variable on the other. Marginal generally refers to small changes. Marginal revenue is change in total revenue per unit change in output sold. Marginal cost refers to change in total costs per unit change in output produced (While incremental cost refers to change in total costs due to change in total output). The decision of a firm to change the price would depend upon the resulting impact/change in marginal revenue and marginal cost. If the marginal revenue is greater than the marginal cost, then the firm should bring about the change in price. Marginal Utility is the utility derived from the additional unit of a commodity consumed. The laws of equi-marginal utility states that a consumer will reach the stage of equilibrium when the marginal utilities of various commodities he consumes are equal. According to the modern economists, this law has been formulated in form of law of proportional marginal utility. It states that the consumer will spend his money-income on different goods in such a way that the marginal utility of each good is proportional to its price, i.e., MUx / Px = MUy / Py = MUz / Pz Where, MU represents marginal utility and P is the price of good. Similarly, a producer who wants to maximize profit (or reach equilibrium) will use the technique of production which satisfies the following condition: MRP1 / MC1 = MRP2 / MC2 = MRP3 / MC3 Where, MRP is marginal revenue product of inputs and MC represents marginal cost. Thus, a manger can make rational decision by allocating/hiring resources in a manner which equalizes the ratio of marginal returns and marginal costs of various use of resources in a specific use.

Market refers to arrangement, whereby buyers and sellers come in contact with each other directly or indirectly, to buy or sell goods." Thus, above statement indicates that face to face contact of buyer and seller is not necessary for market. e.g. in stock or share market, buyer and seller can carry on their transactions through internet. So internet, here forms an arrangement and such arrangement also is included in the market.