3.

2 Law of Returns to Scale :

Alternatively, this law is also known as production function with two variable input.

This law is explained with the help Isoquant and Product / Scale line.

Isoquant / Equal Product Curve/ Production Indifference Curve-

The concept has been derived from the Greek word 'iso' means equal and 'quantus'
means quantity. It is defined as locus of points representing different combinations of
two inputs ( i.e K and L) resulting the same level of output.

Iso-Product Schedule:-

Combination of L & K Units of L Units of K Output MRTSLK

A 1 15 200 -

B 2 11 200 4:1

C 3 8 200 3:1

D 4 6 200 2:1

E 5 5 200 1:1

Iso-Product Curve:- Graphical presentation of iso-product schedule.

Properties of Isoquant:

1. Isoquant has a negative slope- Implies substitution of one input for another so that
output remains the same.

2. Isoquant is convex to the origin- Speaks about Marginal Rate of Technical

ΔK
Substitution(i.e. MRTS = ΔL = Slope of Isoquant ( it measures the rate of reduction in
one factor for an additional unit of another factor in the combination)

3. Isoquants do not intersect or tangent to each other.

4. Upper isoquants represent a higher level of output.

Difference between Equal Product Curve and Indifference curve:

1. Indifference curves indicate level of satisfaction whereas, equal product curves

indicate quantity of output.

2. Indifference curve relate to combinations between two commodities whereas, equal

product curves relate to combination between two factors of production.

3. Indifference curves cannot be easily labelled as there is no numerical measurement

of the satisfaction involved. Equal product curves can be easily labelled as physical
units of output represented by it are measurable.

Product / Scale line:

To analyse the expansion of output, we need a third dimension , since along the two
dimensional diagram we can depict only isoquant along which the level of output is
constant.

The product line shows the movement from one isoquant to another as we change
both factors or single factor ( i.e. it describes the technically possible alternative paths
of expanding output)
The product line starts from the origin if all the factors are variable. If only one factor
is variable, then the product line is a straight line parallel to the axis of the variable
factor.

Explanation of the Law :-

The response of output in a firm when all inputs are varied in equal proportions are
shown by the concept of returns to scale. The term 'returns to scale' refers to the
changes in output as all the factors change by the same proportion.

When both L and K are increased proportionately and simultaneously, there arises
three technical possibilities:

a. Increasing Returns to Scale-

If the output obtained from a production process increases at a faster rate than the rate
of increase in all inputs, then returns to scale are said to be increasing.

Increasing Returns to Scale is due to Economies of Scale arises because of :

i) Technical and Managerial Indivisibilities

ii) Higher Degree of Specialisation

iii) Dimensional Relation.

b. Decreasing Returns to Scale- When the output increases less than proportionately
to increase in inputs.

Decreasing Returns to Scale is due to Diseconomies of Scale arises because of

exhaustibility of natural resources.

c. Constant Returns of Scale- When change in output is proportional to the change in

inputs . It occurs in productive activities in which factors of production are perfectly
divisible.

It is due to limit to economies of scale. As the firm continues to expand its scale of
operations, it gradually exhausts the economies responsible for increasing returns.
Then constant returns may occur.

Managerial Use of Production Functions:

1. If a firm has decided to produce a particular output, it can use the concept of
production function to find out the least-cost combination of factors of production to
produce that output.

2. The producer can find out the maximum output which it can obtain from the use of
a given quantities of factors of production at its disposal. (Producer's Equilibrium)

Producer's Equilibrium is discussed through Isoquant and Isocost line/ Isocline

Isocost line- This concept is similar to the concept of budget line or price line
discussed in the theory of consumer demand.

Isocost line - The isocost line illustrates all the possible combinations of two factors (
i.e. K and L) that can be used at given costs and for a given producer’s budget. In
simple words, an isocost line represents a combination of inputs costing the same
amount.

suppose that a producer has a total budget of Rs 120 and for producing a certain level
of output, he has to spend this amount on 2 factors K and L. Price of factors K and L
are Rs 15 and Rs. 10 respectively.

Combinations Units of Units of Total expenditure

Capital Labour
Price = 150Rs Price = 100 Rs ( in Rupees)
A 8 0 120
B 6 3 120
C 4 6 120
D 2 9 120
E 0 12 120
Note- The slope of the isocost line vary when factor prices vary.

Producer's Equilibrium:

A rational firm is interested in selecting an optimum combination, which yields

maximum benefit or production i.e. the firm is interested in least-cost combination of
factors.

The least-cost combination of factors can be determined by comparing a production

map in relation to a given cost-line. Point of tangency between the iso-cost line and
iso-quant determines producer's equilibrium.