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Prepared by :
Dr. K. BARANIDHARAN
PROF.MBA
SRI SAIRAM INSTITUTE OF TECHNOLOGY
CHENNAI
ENGINEERING ECONOMICS
AND
FINANCIAL ACCOUNTING
Sri Sairam Institute of Technology 2
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EngineeringEconomics& Financial
Accounting
Eefa
315 August 2014
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Return to scale
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RETURNS TO SCALE
Return to scale refer to the return
enjoyed by a firm as a result of change in
all inputs. It explains the behavior of the returns
when inputs are changed
simultaneously.
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Returns to Scale
Returns to scale is the rate at which
output increases in response to
proportional increases in all inputs. In the eighteenth century Adam Smith
became aware of this concept when he
studied the production of pins.
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Returns to Scale
Adam Smith identified two forces that
come into play when all inputs areincreased.
A doubling of inputs permits a greater division
of labor allowing persons to specialize in the
production of specific pin parts.
This specialization may increase efficiency
enough to more than double output.
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Constant Returns to Scale
A production function is said to
exhibit constant returns to scale if a
doubling of all inputs results in aprecise doubling of output.
This situation is shown in Panel .
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Capital
per week
4
A
3
2
1
Laborper week
1 2 3
(a) Constant Returns to Scale
40
Isoquant Maps showing Constant, Decreasing, and
Increasing Returns to Scale
q = 10
q = 20
q = 30
q = 40
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Decreasing Returns to Scale
If doubling all inputs yields less than
a doubling of output, the production
function is said to exhibit decreasingreturns to scale.
This is shown in Panel
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Capital
per week
4
A
3
2
1
Laborper week
1 2 3
(a) Constant Returns to Scale
40
Capitalper week
4
A
3
2
1
Laborper week
1 2 3
(b) Decreasing Returns to Scale
40
Isoquant Maps showing Constant, Decreasing, and
Increasing Returns to Scale
q = 10 q = 10
q = 20q = 20
q = 30q = 30
q = 40
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Increasing Returns to Scale
If doubling all inputs results in more than a
doubling of output, the production function
exhibits increasing returns to scale.
This is demonstrated in Panel
In the real world, more complicated
possibilities may exist such as a production
function that changes from increasing to
constant to decreasing returns to scale.
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Capital
per week
4
A
q = 10
3
2
1
Laborper week
1 2 3
(a) Constant Returns to Scale
40
Capital
per week
4
A
3
2
1
Laborper week
1 2 3
(c) Increasing Returns to Scale
40
Capitalper week
4
A
3
2
1
Laborper week
1 2 3
(b) Decreasing Returns to Scale
40
Isoquant Maps showing Constant, Decreasing, and
Increasing Returns to Scale
q = 10 q = 10
q = 20
q = 20q = 20
q = 30 q = 30
q = 30
q = 40
q = 40
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