Production Function:

Returns to Scale
DR. VIGHNESWARA SWAMY
Production function with two
variable inputs
Table 2: Production with Two Variable Inputs
Capital Labor input
Input
1 2 3 4 5
1 20 40 55 65 75
2 40 60 75 85 90
3 55 75 90 100 105
4 65 85 100 110 115
5 75 90 105 115 120

Isoquant Curve showing all

possible combinations of
inputs that yield the same
output.
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Isoquants
Isoquant Map is a graph combining a number of
isoquants, used to describe a production function.
A set of isoquants, or isoquant map, describes the firm’s
production function.
Output increases as we move from isoquant Q1 (at which
55 units per year are produced at points such as A and
D), to isoquant Q2 (75 units per year at points such as B)
and to isoquant Q3 (90 units per year at points such as C
and E).
By drawing a horizontal line at a particular level of
capital—say 3, we can observe diminishing marginal
returns. Reading the levels of output from each isoquant
as labor is increased, we note that each additional unit of
labor generates less and less additional output.
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Isoquants

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Isoquants
Isoquants show the flexibility that firms have when making production
decisions. They can usually obtain a particular output by substituting
one input for another. It is important for managers to understand the
nature of this flexibility.
Properties of Isoquants:
1. Isoquants are negatively sloped
2. A higher Isoquants represent a larger output
3. No two isoquants intersect or touch each other
4. Isoquants are convex to the origin
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Marginal Rate of Technical Substitution
Marginal Rate of Technical Substitution: The absolute
value of the slope of the isoquant. It equals the ratio
the marginal products of the two inputs. Slope of
isoquant indicates the quantity of one input that can be
traded for another input, while keeping output
constant.
Marginal Rate of Technical Substitution (MRTS) of labor
for capital is the rate at which K must be given up as L
level is increased so as not to change the output level.
OUTCOME: MRTS is the negative slope of the isoquant
curve.

MRTS = -K/L = MPL/MPK

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DR. VIGHNESWARA SWAMY 7
Isocost lines
Isocost line A graph that shows all the combinations of
capital and labor available for a given total cost.

Slope of Isocost line K TC / PK PL

 
L TC / PL PK
Movements of the Isocost line
Change in the budget constraint
The price ratio of the two inputs changes

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Example:
Suppose the marginal product of capital is 40 units of output
and the price of one unit of capital is $10. The marginal
product of labor is 20 units of output and the price of one
unit of labor is $2.

MPK 40 MPL 20
= = 4 < = =1010
pK 10 pL 2

In this case, the firm can reduce the cost of producing its
current level of output by using more labor and less capital.
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How does output respond to increases in
all inputs together?
Increasing returns to scale – Output
increases more than in proportion to
inputs as the scale of a firm’s production
Effect on Output Returns to Scale
increases.
Constant returns to scale – Output f(tk,tl) = tf(k,l) Constant
increases in proportion to inputs as the f(tk,tl) < tf(k,l) Decreasing
scale of a firm’s production increases.
f(tk,tl) > tf(k,l) Increasing
Decreasing returns to scale – Output
increases less than in proportion to
inputs as the scale of a firm’s production
increases.
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Law of Returns to Scale
Increasing marginal returns: region where MP curve is positive and
increasing
Law of diminishing returns: region where marginal product curve is
positive but decreasing
Negative marginal returns: region where product curve is negative so that
TP is decreasing
Law of Diminishing Returns :
◦ Occurs because capital input and technologies are held constant
◦ Additional output generated by additional units of variable input (MP)
◦ Production becomes less constrained

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Returns to Scale
Production Function Q = f(L, K) Returns to scale not
necessarily consistent across
Q = f(hL, hK) levels of output.
One possibility might be:
If  = h, then f has constant returns to scale.
1. There are constant
If  > h, then f has increasing returns to returns to scale for
scale. relatively small plants
If  < h, then f has decreasing returns to 2. There are increasing
scale. returns to scale for
relatively larger plants

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Returns to Scale
Marginal products describe the change in output level as a single
input level changes.
Returns-to-scale describes how the output level changes as all
change in direct proportion (e.g. all input levels doubled, or
halved).
If, for any input bundle (x1,…,xn),

𝒇 𝑲𝑿𝟏 , 𝑲𝑿𝟐,… 𝑲𝑿𝒏 = 𝒌𝒇(𝑿𝟏 , 𝑿𝟐,… 𝑿𝒏 )

then the technology described by the production function f
exhibits constant returns-to-scale.
E.g. (k = 2) doubling all input levels doubles the output level.
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 Returns to Scale
Constant Returns to Increasing Returns to Decreasing Returns to
Scale Constant Returns: Scale Increasing Returns: Scale Decreasing Returns:
The isoquants move Isoquants get
Isoquants are further apart
equally spaced closer together

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Expansion Path Isocost line

A firm’s expansion path Isoquant

illustrates the least-cost
combinations of labor
and capital that can be
used to produce each
level of output in the
long-run.
Firm’s expansion path
has same information as
long-run total cost curve.

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Keywords
Isoquant Curve
Isocost line
Returns to Scale
Constant Returns to Scale
Increasing Returns to Scale
Decreasing Returns to Scale
Marginal Rate of Technical Substitution (MRTS)

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