A firm increases both labour and capital by 20 per cent. As a result, its output rises by 30 per cent. The production function of this firm displays:
Answer & explanation
Correct answer: option 2
The correct answer is Option (2) → Increasing returns to scale
Both inputs rise by 20 per cent, but output rises by more, 30 per cent. This is increasing returns to scale.
Option (1) Decreasing returns to scale — Incorrect. Under DRS, output would rise by less than 20 per cent.
Option (2) Increasing returns to scale — Correct. Output rises by a larger proportion than the inputs.
Option (3) The law of variable proportions — Incorrect. That law applies when one input is fixed and only the other changes. Here both change.
Option (4) Constant returns to scale — Incorrect. Under CRS, output would rise by the same 20 per cent.
NCERT (2026-27): “3.6 Returns to Scale The law of variable proportions arises because factor proportions change as long as one factor is held constant and the other is increased. … Remember that this can happen only in the long run. One special case in the long run occurs when both factors are increased by the same proportion, or factors are scaled up. When a proportional increase in all inputs results in an increase in output by the same proportion, the production function is said to display Constant returns to scale (CRS). When a proportional increase in all inputs results in an increase in output by a larger proportion, the production function is said to display Increasing Returns to Scale (IRS) Decreasing Returns to Scale (DRS) holds when a proportional increase in all inputs results in an increase in output by a smaller proportion. For example, suppose in a production process, all inputs get doubled. As a result, if the output gets doubled, the production function exhibits CRS. If output is less than doubled, then DRS holds, and if it is more than doubled, then IRS holds.” |