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Exercises · Q7
Q.

A firm's labour, capital and resulting output at three successive scales are given below. Both inputs are doubled at each step. Identify the law of returns to scale operating (a) between the first and second rows, and (b) between the second and third rows.

LabourCapitalOutput
1110
2220
4444
Puducherry TnboardTextbookSubjectiveImportance★★★★★
5% · 2/39 Questions
✓ Free question
  1. From (1,1) to (2,2): inputs increase by a factor of 21=2\dfrac{2}{1}=2. Output increases by a factor of 2010=2\dfrac{20}{10}=2. Since the two ratios are EQUAL, output has grown in EXACTLY the same proportion as the inputs — this is Constant Returns to Scale.
  2. From (2,2) to (4,4): inputs increase by a factor of 42=2\dfrac{4}{2}=2. Output increases by a factor of 4420=2.2\dfrac{44}{20}=2.2. Since 2.2>22.2>2, output has grown in a GREATER proportion than the inputs — this is Increasing Returns to Scale. This firm therefore experiences Constant Returns to Scale at first, and then moves into Increasing Returns to Scale as it doubles its scale again — the reverse order from a firm that starts small and eventually runs into diseconomies, illustrating that there is no single fixed sequence a firm must follow; it depends on the specific technology and scale involved.
    ✓Final answer

    (a) Constant Returns to Scale (output ratio 2=2= input ratio 22). (b) Increasing Returns to Scale (output ratio 2.2>2.2> input ratio 22).

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