Decreasing Return To Scale:

Posted by sou on Wednesday, October 14, 2009 / Comments: (0)



The decreasing return to scale prevails when the output increases slower than inputs and vice-versa. Or we can say that when output increases less than proportionately to increase in inputs (capital and labor) and the rate of rise in output goes on decreasing, it is called decreasing return to scale. This can also be explained with the help of the following figure;

In the above figure OA and OB are the product lines indicating two hypothetical techniques of production and isoquants Q1 (10units), Q2 (18units) and Q3 (40units) indicate three different levels of output. When both the inputs are doubled, i.e. from 1K+1L to 2K+2L the output increases from 10units to18units (that is 80% increase), which is less than the proportionate increase in inputs. Similarly the movement from point b to c indicates the increment in the inputs by 50%, whereas the increment in output is only 33.33%. This shows decreasing returns to scale.

REASONS OF DECREASING RETURNS TO SCALE:

Decreasing returns to scale arises mainly because of diseconomies of scale. Some of the diseconomies which cause decreasing returns to scale are;

Ø MANAGERIAL INEFFICIENCY:

Diseconomies begin to start first at the management level. Managerial inefficiencies arise from expansion of scale itself, which eventually decreases the level of output.

Ø EXAHAUSTABILITY OF NATURAL RESORSES:

It also leads to the decreasing returns to scale. For e.g. doubling the size of the coal mining plant does not double the coal output because of limitedness of coal deposits or difficult accessibility to coal deposits.

Ø INEFFICIENT CONTROL:

When the size of the firm is small the owner can efficiently handle and control all the departments individually. With increase in size of the firm (increase in inputs and outputs), various departments are created. Thereby controlling efficiency may decrease creating hindrances in production.

Constant Returns To Scale:

Posted by sou / Comments: (0)


In this stage the scale of inputs and outputs change (increase or decrease) proportionately. We can also say that when change in output is proportional to change in inputs, it shows constant returns to scale. This can be explained with the help of the following figure;





In the above figure product lines OA and OB indicate two hypothetical techniques of production and isoquants Q1 (10units), Q2 (20units) and Q3 (30units) indicate three different levels of output. In the figure movement from point a to b indicates the doubling of both the inputs, from 1K+1L to 2K+2L. When inputs are doubled the outputs are also doubled, i.e. from 10units to 20units. Similarly, the movement from point b to c shows the increment in inputs from 2K+2L to 3K+3L, which is 50% increment. This 50% increment leads to the increment of output from 20units to 30units, which is also 50%. This kind of input output relationship exhibits the constants returns to scale.

REASONS OF CONSTANT RETURNS TO SCALE:

The constant returns to scale arise due to the limits of economies to scale. The producers are unable to efficiently manage the inputs with gradual increase in scale. After certain time period when economies of scale end and diseconomies are yet to begin, the returns to scale appear to be constant. Various communication and coordination, management (personnel, financial, marketing) problems increase with increase in input and output, which leads to diseconomies. Constant returns to scale are transitional stage between increasing and decreasing returns to scale.