Due to 20% increase in all inputs, output is going to increase by 10%. This situation is illustrated by:

Question

Accepted Answer

The correct option is 3:

Diminishing returns to scale describe a production scenario where an increase in all factors of production (inputs) leads to a less than proportionate increase in output. In the long run, when a firm scales up its entire operation—meaning it increases the quantity of labor, capital, and all other inputs—if the output increases by a smaller percentage than the increase in inputs, the firm is experiencing diminishing returns to scale (also called decreasing returns to scale). In this case, a 20% increase in *all* inputs resulted in only a 10% increase in output (10% \< 20%). This indicates that the firm is becoming less efficient as its size increases, often due to management complexities, communication bottlenecks, or logistical difficulties that arise from a larger scale of operations.

The incorrect option is 1:
Increasing returns to scale would occur if the output increased by a greater proportion than the increase in all inputs. For instance, if a 20% increase in inputs led to a 30% increase in output, the firm would be benefiting from economies of scale.

The incorrect option is 2:
Constant returns to scale would occur if the output increased by exactly the same proportion as the increase in all inputs. If the firm experienced a 20% increase in inputs and a resulting 20% increase in output, it would be operating under constant returns to scale.

The incorrect option is 4:
The Law of Variable Proportions (or Diminishing Marginal Returns) is a short-run concept, where at least one factor of production is fixed, and the returns are measured in terms of marginal product. Returns to scale, on the other hand, is a long-run concept where all factors of production are varied simultaneously, as is the case in this question.