OPTIMAL COMBINATION OF INPUTS: RETURNS TO SCALE

RETURN TO SCALE

It describes the rate of increase in production relative to the associates increase in the
factors of production in the long run.

It relates to the long period production function when a firm changes its scale of
production by changing one or more of is factors.

THREE TYPES OF RETURN TO SCALE

1 Increasing returns to scale
2 Constant return to scale
3 Diminishing return to scale

1. Increasing returns to scale

■ Increasing returns to scale happen when all the factors of production are
increased; at this point, the output increases at a higher rate.
2. Constant Return to Scale
■ This occurs when the output increases in exactly the same proportion as the factors of
production.

3. Diminishing returns to scale

■ Decreasing returns to scale are taking place when all the factors of the production
increase in a given proportion, but the output increases at a lesser rate than that of the
increase in factors of the production.
Empirical Production Function

A production function relates physical output of a production process to physical inputs

or factors of production. It is a mathematical function that relates the maximum amount of output
that can be obtained from a given number of inputs – generally capital and labor. The production
function, therefore, describes a boundary or frontier representing the limit of output obtainable
from each feasible combination of inputs.

In 1928, Charles Cobb and Paul Douglas presented the view that production output is the
result of the amount of labor and physical capital invested. It is based on empirical studies which
means it can be applied. This analysis produced a calculation that is still in use today, largely
because of its accuracy. Empirically it was found that, 75% increase in output can be attributed
to increase in labour input and the remaining 25% was due to capital input.

It is a linear homogeneous production function of degree one which takes into account
two inputs, labour and capital, for the entire output of the manufacturing industry.

Q = ALα K β
Q = total production (the real value of all goods produced in a year

L = labour input (the total number of person-hours worked in a year

K = capital input (the real value of all machinery, equipment, and buildings)

A = total factor productivity ( measure of productivity calculated by dividing economy-wide total

production by the weighted average of inputs i.e. labor and capital)

β and α output elasticity

Output elasticity measures the responsiveness of output to a change in levels of either

labor or capital used in production, For example if α = 0.15, a 1% increase in labor would lead to
approximately a 0.15% increase in output.

Further, if: α + β = 1, the production function has constant returns to scale. That is, if L
and K are each increased by 20%, then P increases by 20%.

However, if α + β < 1, returns to scale are decreasing, and if α + β > 1, returns to scale are
increasing. Assuming perfect competition, α and β can be shown to be labor and capital’s share
of output.
 Example
Year 1899 1900 1901 1902 1903 1904 1905 ... 1918 1919 1920

Q 100 101 112 122 124 122 143 ... 223 218 231

L 100 105 110 117 122 121 125 ... 201 196 194

K 100 107 114 122 131 138 149 ... 366 387 407

Table 1: Economic data of the American economy during the period 1899 – 1920

Using the economic data published by the government , Cobb and Douglas took the year
1899 as a baseline, and P, L, and K for 1899 were each assigned the value 100.

Next, Cobb and Douglas used the method of least squares to fit the data of Table 1 to the
function:

Q (L, K) = 1.01(L 0.75)(K0.25)

For example, if the values for the years 1904 and 1920 were plugged in:

Q (121, 138) = 1.01(121^0.75)(138^0.25) ≈ 126.3

Q (194, 407) = 1.01(194^0.75)(407^0.25) ≈ 235.8
Which are quite close to the actual values, 122 and 231 respectively.

Criticism

Neither Cobb nor Douglas provided any theoretical reason why the coefficients α and β
should be constant over time or be the same between sectors of the economy. Remember that the
nature of the machinery and other capital goods (the K) differs between time-periods and
according to what is being produced. So do the skills of labor (the L).

The Cobb-Douglas production function was not developed on the basis of any knowledge
of engineering, technology, or management of the production process. It was instead developed
because it had attractive mathematical characteristics, such as diminishing marginal returns to
either factor of production.
 INNOVATION AND GLOBAL COMPETITIVENESS

Let’s discuss about innovation and global competitiveness, we will start by defining these
terms and then we will correlate the terms then lastly, we will discuss the whole concept.

Innovation

Innovation is one of the most bandied about terms in global business today, but exactly
what it means can be nebulous. In which we can describe innovation through words: Original,
unexpected, fresh, never been thought of before, never been seen before, creative, new, useful or
as strategic Criteria such as:

 Creating meaningful points of difference for products and services vs. current
alternatives
 Fulfilling unmet consumer needs, by offering new ways to accomplish goals, or
make lives or jobs easier, better, happier, more exciting, satisfying, or more
productive
 Enabling brands to compete in incremental new markets or category segments
 Delighting/engaging/capturing imaginations of consumers to increase loyalty

Global Competitiveness

When we say Global it basically means around the world, across different countries while
competitiveness is mainly associated with productivity. Competitiveness is defined by the
Economic Forum as “the set of institutions, policies and factors that determine the level of
productivity of a country”.

The International Institute for Management Development defines competitiveness as "a

field of economic knowledge which analyzes the facts and policies that shaped the ability of a
nation to create and maintain an environment that sustains more value creation for its enterprises
and more prosperity for its people."

The World Economic Forum defines global competitiveness as "the ability of a country to
achieve sustained high rates of growth in gross domestic product (GDP) per capita."
Moving on, innovation is associated with global competitiveness for it is part or essential
for the development of the so called competitiveness globally.
Factors Affecting Global Competitiveness

Business firms abide by the rules and regulations formed by the government. The
government assumes a very important role in enhancing competitiveness. Governments must
promote trade by reengineering systems and procedures. Governments should be more
responsive, reducing bureaucratic red tape.

 Physical infrastructure plays a critical role in improving the global competitiveness of a

country. This will lead to the smoother movement of people, products, and services,
facilitating faster delivery of goods and services.

 The business environment should be as such that it improves coordination among

public-sector agencies. The best methods include providing support and incentives for
R&D activities, HRD and education, encouraging innovativeness and creativity,
facilitating the improvement of industrial blocks, and productivity enhancements of
SMEs.
 High total factor productivity (TFP) is a boon for economic growth. It shows the
synergy and efficiency of both capital and HR utilization and promotes national
competitiveness.
 Productivity campaigns are important because they promote public-awareness and
provide mechanisms to use the productivity tools and techniques.
 Intensifying R&D activities that contribute to creativity, innovation, and indigenous
technological development is also an important factor.
 Improving the capacities of SMEs to become increasingly productive suppliers and
exporters makes strategic sense.

Global Competitiveness Index

Global Competitiveness is measured by a report published yearly by the World Economic

Forum, it is called The Global Competitiveness Report. Since 2004, the Global Competitiveness
Report ranks countries based on the Global Competitiveness Index.

The Global Competitiveness Reports asses the competitiveness landscape of 144

economies of the world. It provides information about the drivers of their productivity and
prosperity. The Report is the most comprehensive assessment of national competitiveness
worldwide.

The Philippines ranked from 56th in 2018 to 64th in 2019.

History of effects of innovation to Global Competitiveness

As we all know, there is a phase in the product life cycle which is the maturity period. In
this phase it is crucial for the business because it is either it will maintain its operations and stay
in the competition or go to the last phase which is decline. The reason behind business facing
maturity phase is because of the growing competition of that particular industry.

Innovation has been the greatest weapon in the competition. But actually, firms that first
introduced innovation eventually lose their export market and even their domestic market to
foreign imitators who pay lower wages and generally face lower costs.

Technologically leading firms were the one that were able to maximize the concept of
innovation. Back in 1970s – 1980s Japan was on the lead, because America has been focusing on
product innovation while Japan focused on the innovation of their production process which
gave them the opportunity to maximize not only their resources but also their time. Best example
of the most successful Japanese firm that advanced because of innovation is the Toyota
Corporation that has been practicing JIT system.