LONG RUN PRODUCTION FUNCTION OR LAW OF RETURNS TO SCALE

The law of returns to scale is applicable in the long run where all factors of
production are in variable supply. In the long run output can be increased by
increasing all the factors of production or the ‘scale’ of production.

1. Statement of the Law: The law of returns to scale, states that when all
factors of production are increased in the same proportion, output will increase
but the increase may be at increasing rate or constant rate or decreasing rate

2. Three types of Law of Returns to Scale

1. Increasing Returns to Scale

2. Constant Returns to Scale

3. Decreasing Returns to Scale

1) Increasing Returns to Scale

It occurs when increase in output is more than proportional to an increase in

inputs. In other words, when the proportionate increase in output is greater
than proportionate increase in inputs, increasing returns exist for example, if
labour and capital are the only two inputs and they are increased by 10% then
output increase by more than 10%. If labour and capital are doubled then the
resultant increase in the output is more than double.

Table 1: Increasing Returns to scale

Combination Capital Labour Output

A 10 10 100
B 18 18 200
C 23 23 300
D 26 26 400

Increasing returns to scale implies decreasing costs and decreasing costs are
due to economies of large scale production, which takes place by increasing the
scale of operation. The increasing returns to scale is explained with the help of
a hypothetical example in table 1.

In table 1 combination A shows that, using 10 units of capital and 10 units of

labour 100 units of output is produced. For increasing the output by 100 at
combination B, 8 units of capital and 8 units of labour are required, thus
combination B shows that 18 units of capital and 18 units of labour can
produce 200 units of output. Similarly combination C shows that additional 5
units of each factor of production will produce additional 100 units of output.
At combination D, additional 3 units of each factor production will produce
additional 100 units of output.

Y
S1
S1

S
CAPITAL

D1

C1
D S2
B1 C D2
C2 IQ3(400)
A1 B
IQ2(300)
A B2
A2 IQ1(200)

0 IQ(100)

X
LABOUR

Figure 1: Increasing Returns to scale

Thus from combination A to D it can be seen that for producing additional 100
units of output, lesser quantity of inputs are required. This is due to the
increasing efficiency of the inputs. This is explained in figure 1, where capital is
measured on Y axis and labour on x-axis. Iso-quants IQ, IQ1, IQ2 and IQ3
show the level of output 100, 200, 300 and 400 respectively. 0s, 0s1 and 0s2
are the scale lines. As there is increasing returns to scale the distance between
the iso-quants is decreasing showing reduction in the number of inputs i.e
OA>AB>BC>CD.

Stage II: Constant Returns to Scale

It occurs when increase in output is proportional to an increase in inputs. In

other words, when the proportionate increase in output is equal to the
proportionate increase in inputs, constant returns exist.

Table 2 Constant Returns to scale

Combination Capital Labour Output

A 10 10 100
B 20 20 200
C 30 30 300
D 40 40 400

Y
S1
D1
S

C1 D
CAPITAL

S2
C D2
B1 IQ3(400)

C2
A1 B
IQ2(300)
B2
A IQ1(200)
A2
IQ(100)
0
LABOUR X

Figure 2: Constant Returns to scale

For example, an increase in inputs by 10% resulting in increase in output by
10%. If labour and capital are doubled, output also doubles. Constant returns
implies constant costs and constant costs are due to constant economies of
scale. That is an increase in the capacity of the firm has no effect on the long
run average cost of production. In Table 2 combination A shows that, using 10
units of capital and 10 units of labour 100 units of output is produced. For
increasing the output by 100 at combination B, 10 units of capital and 10
units of labour are required, thus combination B shows that 20 units of capital
and 20 units of labour can produce 200 units of output. Similarly combination
C shows that additional 10 units of each factor of production will produce
additional 100 units of output. At combination D, additional 10 units of each
factor production will produce additional 100 units of output. Thus from
combination A to D for producing every additional 100 units of output, equal
quantity of inputs are required. All the units of input have similar efficiency.

The constant returns to scale is explained in figure 2, where, capital is

measured on Y axis and labour on x-axis. Iso-quants IQ, IQ1, IQ2 and IQ3
show the level of output 100, 200, 300 and 400 respectively. 0S, 0S1 and 0S2
are the scale lines. As there is constant returns to scale the distance between
the Iso-quants is equal, showing an increase in equal quantity of number of
inputs i.e OA=AB=BC=CD.

Stage III: Decreasing Returns to Scale:

It occurs when increase in output is less than proportional to an increase in

inputs. When the proportionate increase in output is less than the
proportionate increase in input, the constant returns to scale exist. For
example, if labour and capital increase by 10% output will increase by less
than 10%. If labour and capital are doubled, output less than doubles.
Decreasing returns to scale implies increasing costs and increasing costs are
due to diseconomies of large scale production. There is managerial inefficiency
caused by scarce supply of factors of production and imperfect substitution.
The manager is overburdened and faces the problems of control and
coordination.

Table 3 Decreasing Returns to scale

Combination Capital Labour Output

A 10 10 100
B 22 22 200
C 35 35 300
D 55 55 400

Y
D1 S1

SS

C1 D
CAPITAL
CAPITAL

S2
D2
C
B1 IQ3(400)

C2
A1 B
IQ2(300)

A B2
IQ1(200)
A2
IQ(100)
0
X
LABOUR

Figure 3: Decreasing returns to scale

In table 3 combination A shows that, using 10 units of capital and 10 units of

labour 100 units of output is produced. For increasing the output by 100 at
combination B, 12 units of capital and 12 units of labour are required, thus
combination B shows that 22 units of capital and 22 units of labour can
produce 200 units of output. Similarly combination C shows that additional 20
units of each factor of production will produce additional 100 units of output.
At combination D, additional 20 units of each factor production will produce
additional 100 units of output. Thus from combination A to D for producing
each additional 100 units of output, larger quantity of inputs are required. The
efficiency of subsequent units of labour is decreasing.

The decreasing returns to scale is explained in figure 5.4 where capital is

measured on Y axis and labour on x-axis. Iso-quants IQ, IQ1, IQ2 and IQ3
show the level of output 100, 200, 300 and 400 respectively. 0S, 0S1 and 0S2
are the scale lines. As there is decreasing returns to scale the distance between
the Iso-quants is increasing showing increase in the number of inputs i.e
OA<AB<BC<CD.