Law of Returns to Scale and Law of Variable Proportion

Law of Returns to Scale

The long term production phenomena is described by the law of returns scale. Over time, it is possible to alter all production parameters to boost output. In other words, since the company has enough time to make changes to all the components, they are all variable in the long term. Therefore, this rule defines the rate of change in output due to the same proportionate or percentage change in the input, i.e., labor (K), and capital (K) (L). We refer to this as a shift in the scale of production when all inputs are altered in the same ratio. The Law of Returns to Scale is a theory that examines how output changes as a function of manufacturing scale. This theory proposes three different returns to scale categories for the production process.

Increasing Returns to Scale (IRS)

This phase of IRS is present if the proportionate change in output is larger or equal to the proportionate change in inputs. The average product (AP) and marginal product (MP) grow with the proportionate or percentage variance in all inputs, which is when the increasing returns to scale work in production. Imagine that when the inputs (labor and capital) double, the output grows by more than two times. IRS's motivations:

• Technical managerial independence is greater.
• Specialization level.
• The X-axis and Y-axis in the figure measure labor and capital, respectively. Ten units are produced overall if L and C are used in one unit each. If we double the input, the output will increase by 25 units. If input is increased three times, the output is 55 units. In light of this, the proportionate or percentage change in output exceeds the change in intake.
• Inputs' indivisibility, notably in regard to equipment, administration, marketing expertise, etc. These inputs cannot be cut into smaller pieces to accommodate a tiny scale of production.

Decreasing Returns to Scale (DRS)

This phase is known as DRS if the output changes proportionately or by a greater percentage than the input changes, such as labor and capital, do. In other words, when the marginal product (MP) and average product (AP) both fall with the proportional variation in all inputs, the falling returns to scale are at work in the production process. For instance, when inputs are doubled, the proportionate change in output is less than twice that.

Reasons behind DRS are:

• The difficulty of management
• Entrepreneurship is a constant factor.
• Resources in nature are finite.

Constant Returns to Scale (CRS):

CRS is used when both the proportionate or percentage change in the input and the output are equal. Input and output fluctuate proportionately or proportionately as a percentage of each other. In other words, the constant returns to scale rule applies to production if the marginal and average product both remain constant or unchanging with the proportionate variation in all inputs.

Reasons behind CRS are:

• Limitations of Economies of Scale
• Divisibility of inputs

Law of Variable Proportion

The short run production phenomena is explained by the law of variable production. The law of variable proportion, commonly referred to as the law of declining returns, illustrates the overall impact on the output of a proportionate change in one variable input (in this case, labor) with constant units of fixed inputs. If we want to change the result in the near term, we can only change the variable factors; the fixed factors cannot be changed. According to this law, if we use increasingly more units of the variable, or labor, with a given fixed factor, or capital, then in the initial phase total production increases at increasing rate to some extent and increases at decreasing rate, increases at constant rate until it reaches its maximum, and then it starts to decline at increasing rate. This law is based on following assumptions:

• Technology for manufacturing is continual.
• Labor is a homogenous, single-variable component.
• It must be possible to alter the distribution of the production elements.

Reference

Koutosoyianis, A (1979), Modern Microeconomics, London Macmillan