In the long run, all factors of production are variable. How the output of a business responds to a change in factor inputs is called returns to scale.
- When we double the factor inputs from (150L + 20K) to (300L + 40K) then the percentage change in output is 150% – there are increasing returns to scale.
- When the scale of production is changed from (600L + 80K0 to (750L + 100K) then the percentage change in output (13%) is less than the change in inputs (25%) implying a situation of decreasing returns to scale
- Increasing returns to scale occur when the % change in output > % change in inputs
- Decreasing returns to scale occur when the % change in output < % change in inputs
- Constant returns to scale occur when the % change in output = % change in inputs
The nature of the returns to scale affects the shape of a business’s long run average cost curve.
Finding an optimal mix between labour and capital
In the long run businesses will be looking to find an output that combines labour and capital in a way that maximises productivity and therefore reduces unit costs towards their lowest level. This may involve a process of capital-labour substitution where capital machinery and new technology replaces some of the labour input.
In many industries over the years we have seen a rise in the capital intensity of production – good examples include farming, banking and retailing.
Robotic technology is extensively used in many manufacturing / assembly industries such as cars and semi-conductors. The image above is of a Ford car assembly factory in India.