Returns to Scale

Introduction In the long run production of a commodity can be varied by changing all inputs simultaneously and in the same proportion (including fixed inputs). Change in scale of production refers to a stage when all factor inputs are changed in the same proportion. The way total output changes due to change in scale of production in long-run is known as law of returns to scale. Returns to Scale is defined into three stages as Constant Returns to Scale, Increasing Returns to Scale and Decreasing Returns to Scale. Constant Returns to Scale occurs when increase in output is proportionately equal to increase in all inputs. Increasing Returns to Scale occurs when increase in output is proportionately greater than increase in all inputs. Decreasing Returns to Scale occurs when increase in output is proportionately smaller than increase in all inputs. Returns to scale are generally explained in terms of ‘economies’ and ‘diseconomies’ of scale. Economies of scale are classified into internal economies and external economies. Diseconomies of scale again are classified into two: internal diseconomies and external diseconomies. The causes of economies of scale which results in increasing returns to scale induce: Indivisibilities and greater specialization. The causes of constant returns to scale can be explained in terms of limits of economies of scale. The causes of decreasing returns to scale are explained in terms of Complexity of management, exhaustibility of natural resources, etc.

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  • Q1

    Problems like low employees morale, managerial difficulties, higher input prices etc. arising due to large scale operations leads to:

    Marks:1
    Answer:

    Diseconomies of Scale

    Explanation:

    Diseconomies of scale refer to forces which increases the average cost of producing a product as the firm expands the size of the plant.

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  • Q2

    If 1 unit of labour and 1 unit of capital gives 100 units of output and 2 units of labour and 2 units of capital gives 80 units of output then this is a case of:

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    Answer:

    Decreasing Returns to Scale

    Explanation:

    Under decreasing returns to scale output increases in a smaller proportion with an increase in all inputs. This is generally due to internal and external diseconomies.

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  • Q3

    In a small scale shoe manufacturing plant, factors of production were increased by 10% which caused similar increase in output. This implies that the firm is experiencing:

    Marks:1
    Answer:

    Constant Returns to Scale

    Explanation:

    Under constant returns to scale output increases in the same proportion as that of the proportion in which other factors of production  are increases.

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  • Q4

    In the very beginning of production, there will be increasing returns to scale due to:

    Marks:1
    Answer:

    Both (1) and (2)

    Explanation:

    In the initial stage output increases in a greater proportion than the increase in inputs generally due to the internal economies faced by firms like indivisibility of factors and possibilities of specialisation in factors.

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  • Q5

    The law of returns to scale operates in _______ period.

    Marks:1
    Answer:

    long -run

    Explanation:

    In the long run production of a commodity can be varied by changing all inputs simultaneously and in the same proportion (including fixed inputs).

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