Economics Notes on Factors of Production and Law of Return to Scale

Meaning and Factors of Production

Every entrepreneur employs four factors of inputs for the production of goods and services in the economy. The four factors of inputs are:

• Capital
• Land
• Labour
• Entrepreneurship

These four factors of input help the entrepreneur to produce the goods and services in the economy for the fulfillment of needs, wants and desires of the consumers and customers.

With the four inputs, as the entrepreneur puts them into the production of goods and services. But what about the output? What does the entrepreneur gets in return after employing these inputs?

The answer has been given in the table.

• The capital that the entrepreneur invests gets interest.
• The land, on which the business is set up, gets rent in return.
• The labour that is engaged in the physical production of the goods and services gets wages in return for the hard work
•  Entrepreneur gets profit in return for his business ideas. 

The Law of Returns to Scale

The laws of returns to scale refer to the effects of a change in the scale of factors (inputs) upon output in the long run when the combinations of factors are changed in the same proportion.

The laws of returns to scale are a set of three interrelated and sequential laws of:

1. Lawof Increasing Returns to Scale
2. Lawof Constant Returns to Scale
3. Law of Diminishingreturns to Scale

Before starting with an explanation, we will assume that we are using only two factors of production, Labour denoted by L and Capital denoted by K. Therefore, we are using the combination:1L + 1K from the initial stage. Let us look into the first set:

The law of Increasing Returns to Scale (IRS):

As stated above, we have taken 1L + 1K as the initial inputs for the production.Now if we double the factors of production to 2L + 2K, the output increases from 100 to 250. The change in the output is more than 100% i.e. 150%, this means that we have Increasing Returns to Scale as we double the units of Inputs.

The law of Constant Returns to Scale (CRS):

As stated above, we have taken 1L + 1K as the initial inputs for the production.Now if we double the factors of production to 2L + 2K, the output increases from 100 to 200. The change in the output is exactly 100%, this means that we have Constant Returns to Scale as we double the units of Inputs.

 The law of Decreasing Returns to Scale (CRS):

As stated above, we have taken 1L + 1K as the initial inputs for the production.Now if we double the factors of production to 2L + 2K, the output increases from 100 to 190. The change in the output is less than 100% i.e. 90%, this means that we have Decreasing Returns to Scale as we double the units of Inputs.

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