Laws of Production

by

Balaji K

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

2

Law of Variable Proposition
It is also known as ³Law 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. 

3

Definition of Law of Variable Proportions 

³as more and more of some input,¶I¶ is employed,all other input quantities L being held constant,eventually a point will be reached where additional quantities of input µI¶ will yield diminishing marginal contributions to total product´- Baumol
D

4

Three stages of the Law
Fixed Factor 1 1 1 1 1 1 1 1 Variable Factor 1 Total Product 100 Average Product 100 110 90 75 64 55 47 40 Marginal Product 0 120 50 30 20 10 0 -10
5

L
2 3 4 5 6 7 8

D

220 270 300 320 330 330 320

Three stages of Prod . Fn in short
Stage 1: Increasing Returns to Scale When average product (AP) is rising ,Marginal Product (MP) rises more than AP Stage 2:Constant Returns to Scale When AP is Maximum and constant,MP becomes equal to AP Stage 3:Diminishing Returns to Scale When AP starts falling,MP falls faster than AP

8

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.

9

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 10 lesser output

Table 1 :Increasing Returns to Scale
Factors Labour Land (Units) (acres) 1 : 2 Total Product Marginal Product or Return in Units 4

4

2

:

4

10

6

3

:

6

18

8

4

:

8

28

10

11

Table 2 :Constant Returns to Scale
Factors Labour Land (Units) (acres) 5 6 : : 10 12 Total Product Marginal Product or Return in Units 10 10

38 48

12

Table 3 Decreasing Returns to Scale
Factors Labour Land (Units) (acres) 7 : 14 Total Product Marginal Product or Return in Units 8

56

8

:

16

52

6

13

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.

16

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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Complements (-) vs Substitutes (+) defined by sign of cross price elasticity
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