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Saturday, 8 September 2018

Production function (Returns to Scale)

Returns to Scale

Returns to scale is meant the behavior of production or returns when all the factors(labour and capital) are increased or decreased simultaneously in the same ratio. In returns to scale we analyse the effect of doubling , trebling and so on of all the input factors on the output of product.

returns to scale
Returns to Scale

Returns to scale is different from the returns to factors. Output can be increased only by increasing variable factor. Capital remains constant in this case. While in returns to scale, output can be increased by increasing both factors in such a way that proportion among the factors remain same.



Phases of Law

A layman can reach to the conclusion that by doubling and trebling the input factors , output will also be doubled and trebled. But actually this is not correct. It does not happen. According to change in scale output does not change in same proportion. Similar to the law of variable proportions when scale are increased, marginal product increase in first stage, then constant and decrease.

Therefore there are three phases of returns to scale:

1. Increasing Returns
2. Constant Returns
3. Decreasing Returns

Explanation

First stage is the stage of increasing returns due to decreasing marginal cost. Second stage is stage of constant returns. If produce don't stop here then he slips into third stage where returns starts to decrease due to increasing marginal cost.

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