Law of Return to Scale and it's Classification

Law of Return to Scale

The law of returns to scale explains the proportional change in output with respect to proportional change in inputs.

In other words, the law of returns to scale states when there is a proportionate change in the amounts of inputs, the behavior of output also changes. The degree of change in output varies with change in the amount of inputs.

Law of returns can be classified into following three categories:

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

Increasing Returns to Scale:

If the proportional change in the output of an organization is greater than the proportional change in inputs, the production is said to reflect increasing returns to scale.

For example: To produce a particular product, if the quantity of inputs is doubled and the increase in output is more than double, it is said to be an increasing returns to scale.

When there is an increase in the scale of production, the average cost per unit produced is lower. This is because at this stage an organization enjoys high economies of scale.

Constant Returns to Scale:

The production is said to generate constant returns to scale when the proportionate change in input is equal to the proportionate change in output.

For example: When inputs are doubled, so output should also be doubled, then it is a case of constant returns to scale

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Diminishing Returns to Scale:

Diminishing returns to scale refers to a situation when the proportionate change in output is less than the proportionate change in input.

For example: When capital and labor is doubled but the output generated is less than doubled, the returns to scale would be termed as diminishing returns to scale.

Table 1: Returns to Scale

Unit	Scale of Production	Total Returns	Marginal Returns
1	1 Labor + 2 Acres of Land	4	4	(Stage I – Increasing Returns)
2	2 Labor + 4 Acres of Land	10	6
3	3 Labor + 6 Acres of Land	18	8
4	4 Labor + 8 Acres of Land	28	10	(Stage II - Constant Returns)
5	5 Labor + 10 Acres of Land	38	10
6	6 Labor + 12 Acres of Land	48	10
7	7 Labor + 14 Acres of Land	56	8	(Stage III - Decreasing Returns)
8	8 Labor + 16 Acres of Land	62	6