Increasing Returns to Scale

Law of Increasing Returns to Scale

This law states that the volume of output keeps on increasing with every increase in the inputs. Where a given increase in inputs leads to a more than proportionate increase in the output, the law of increasing returns to scale is said to operate. We can introduce division of labour and other technological means to increase production. Hence, the total prod­uct increases at an increasing rate.


— In the words of Marshall, "An increase of labour and capital leads generally to improved organisation which increases the efficiency of the work of labour and capital. Therefore, an increase of labour and capital generally gives a return which increases more than in proportion."

— According to Benham, "As the proportion of one factor in a combination of factors is increased, upto a point, the marginal productivity of the factor will increase."

— In the words of Mrs. Joan Robinson, "Increasing Returns to a factor states that when an increasing amount of a factor of production is employed it generally brings about an improvement in organisation. As a result of it, units of the factor concerned become more efficient and to increase production it will not be necessary to increase the physical quantity of the factor in the same proportion."

If the proportional increase in output (production) is larger than that of the inputs, then we have increasing returns to scale.

All factors of production (land, labor and capital) have been doubled, there is 100 percent increase in the factors of production whereas output has increased from 10 units to 25 units, which is more than double. There is an increase in output by 150%. It means increase in all inputs leads to a more than proportional increase in the output of the firm. Here increasing returns to scale is operating. Increasing returns to scale is achieved in the manufacturing industries.

FACTS: When robots replace people at the workplace

As machines move deeper and deeper into the work place, what are the humans left to do? Machine layout is made more efficient, and the new machines require fewer people to operate. This is considered progress, and has been going on from time immemorial. The economists celebrate this with their term ‘labour productivity' — if we employ fewer people for the same output, labour productivity goes up.

During 2000-2007, productivity in the non-farm business sector in the US went up by 2.5 per cent a year and slowed slightly to 1.9 per cent a year during 2007-2011. Productivity can help boost living standards since firms can now increase wages, but alternatively, when demand is sluggish, firms can slow down hiring and show greater profits. And in spite of a sluggish economy, firms have been showing healthy profits and unemployment remains high.

At some level, we welcome the substitution of people with equipment and machines. These would include jobs that are hazardous; where the use of a machine would make human lives safer. Or the job may be routine — that it frees the human to make better use of his or her brain.

The coming of computing and information technologies has speeded up this process in significant ways. Think about the services now facilitated by technology which previously required human interaction. At the ATM, money is available when you want it, while you had to previously stand in a line at the bank teller. You get your statement online and fewer tellers are now needed. You do your banking online, and send fewer cheques. Many grocery stores have added self-check-out counters and fewer sales staff are needed. Online purchases have reduced the need for brick-and-mortar stores in some areas, most notably, book stores.

Sure, there are more people needed in the new industries, for managing logistics, in shipping companies, and so on. But on the balance, the deal seems skewed in favour of technology.

Technology has also created a world where a few smart and savvy individuals have started companies, and created products and services that has brought them enormous wealth while the jobs and services that employ people who spend their money on these products and services has been shrinking.

More leisure, less money

Meanwhile, the people, with less to do, are producing more babies. We hit 7 billion recently. What do we have for them to do? The International Labour Organisation warns that we need to create 600 million jobs over the next decade.

It reminded me of the apocryphal story about the head of a car manufacturing company who was touring the production area with the head of the union. Looking at the robots doing the welding, the executive tells the union president, ‘I don't think those robots will be joining your union and paying dues.' The union leader replies, ‘I hope you pay those robots well so they will be able to buy your cars.'

I think if we are not careful about the substitution between labour and technology, we will rapidly be in a situation where we have plenty of leisure from lack of work, and less money in the pockets.