Question

What is the role of constant returns to scale in the distribution of income?

Answer 1

ANSWER:

A production function has constant return to scale (CRS) when changing all inputs by an equal percentage causes an increase in output of the same percentage. Under constant returns to scale the economic profit is zero. The role of constant returns to scale in the income distribution is as follows:

- Productivity as well as population both increases.

- When some of increasing population is required to produce commodities and services, unemployment will increase unless more and more commodities and services are demanded.

- Higher unemployment together with reduces social benefits spending, and increases the poverty

- With an increase in unemployment the relative tax collections reduces, stimulating the government to apply even more cuts to federal spending.

-- The “reform” proposals in tax such as “broadening the tax base,” increases in FICA and all sales-related taxes, have higher impact on the not-rich compared to the rich.