Laws of Production

by

Balaji K

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Overview Laws of Variable Proportions Stages of Production function Returns to Scale and its Types Economies of Scale Types of Economies of Scale Factors/Causes of Internal and external economies

of scale Diseconomies of small scale and large scale

production

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Law of Variable Proposition It is also known as “Law of Diminishing

Returns” Assumption:

A firm’s production function consists of fixed quantities of all inputs (land,equipment etc)except labour which is a variable input.When the firm expands output by employing more and more labour,it alters the proportion between fixed and the variable inputs.

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Definition of Law of Variable Proportions

D

“as more and more of some input,’I’ is employed,all other input quantities being held constant,eventually a point will be reached where additional quantities of input ‘I’ will yield diminishing marginal contributions to total product”- Baumol

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Three stages of the Law

D

Fixed Factor

Variable Factor

Total Product

Average Product

Marginal Product

1 1 100 100 0

1 2 220 110 120

1 3 270 90 50

1 4 300 75 30

1 5 320 64 20

1 6 330 55 10

1 7 330 47 0

1 8 320 40 -10

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Three stages of Prod . Fn in short

Stage 1: Increasing Returns to ScaleWhen average product (AP) is rising ,Marginal Product

(MP) rises more than AP

Stage 2:Constant Returns to ScaleWhen AP is Maximum and constant,MP becomes equal to

AP

Stage 3:Diminishing Returns to ScaleWhen AP starts falling,MP falls faster than AP

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Contnd

Thus ,the total product,marginal product and average product pass through three phases viz,increasing,diminishing and negative return stage.The law of variable proportion is nothing but the combination of law of increasing and diminishing returns.

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Question

Why Increasing ,Diminishing and Negative Returns?

Why Increasing?Fixed factor is abundant relative to the quantity of the variable

factor.It is also due to indivisibility of fixed factor

Why Diminishing ?Any increase in variable factor beyond this point of optimum

will always result in Diminishing returns.

Why Negative?Too much employment of variable factor,Greater costs and

lesser output

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Table 1 :Increasing Returns to Scale

FactorsLabour Land (Units) (acres)

Total Product Marginal Product or Return in Units

1 : 2 4 4

2 : 4 10 6

3 : 6 18 8

4 : 8 28 10

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Table 2 :Constant Returns to Scale

FactorsLabour Land (Units) (acres)

Total Product Marginal Product or Return in Units

5 : 10 38 10

6 : 12 48 10

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Table 3 Decreasing Returns to Scale

FactorsLabour Land (Units) (acres)

Total Product Marginal Product or Return in Units

7 : 14 56 8

8 : 16 52 6

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Economies of Scale

Production may be carried on a small scale or on a large scale by a firm.When a firm expands its size of production by increasing all the factors,it secures certain advantages known as economies of Production.

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Types of Economies of Scale

Internal Economies

External Economies

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Internal Economies of Scale

These are those which are opened to a single factory or a single firm independently of the action of other firms.They result from an increase in the scale of output of a firm and cannot be achieved unless output increases.

Hence,internal economies depend solely upon the size of the firm and are different firms.

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External Economies of Scale

The benefits of those which are shared in by a number of industries when the scale of production in an industry or group of Industries increases.

Hence,external economies benefit all the industries as the size of the industry increases.

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Causes of Internal Economies of Scale

1.Indivisibilities

2.Specilisation

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Types of Internal Economies of Scale

1.Technical Economies

2.Managerial Economies

3.Marketing Economies

4.Financial Economies

5.Risk Bearing Economies

6.Economies of Research

7.Economies of Welfare

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Types of External Economies of Scale

1.Economies of Concentration

2.Economies of Information

3.Economies of Welfare

4.Economies of disintegration

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Diseconomies of large Scale Production

Financial,Marketing ,Managerial ,Technical

Diseconomies of risk taking and external diseconomies

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What are merits and demerits of Small scale production

Compare and contrast from one industry to other industry

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Thank You

Complements (-) vs Substitutes (+)

defined by sign of cross price elasticity