kCDUC1ICN LAWS AND 1nLCkILS

kCDUC1ICN
roducLlon ls Lhe process whereby lnpuLs are Lransformed lnLo
ouLpuLs"

1nLCk CI kCDUC1ICN
1heory of roducLlon conslsL of how Lhe producer glven Lhe sLaLe
of Lechnology comblnes varlous lnpuLs Lo produce a deflnlLe amounL
of ouLpuL ln an economlcally efflclenL manner"
1heory of producLlon malnly conslsL of Lwo Lhlngs
1 roducLlon funcLlon
2 Laws of producLlon laws of reLurn

kCDUC1ICN IUNC1ICN
In the analysis oI input-output relations and production Iunction is
expressed as-
Q F (L, K)
Where, Q the quantity oI coal produced per unit time
K Capital;
L Labour
The above equation implies that quantity produced depends
on the quantity oI capital K, and labour L, 'employed to
produce a commodity. Whether the Iirm can increase both K
and L or only L depends on the time period it takes into
account Ior increasing production, i.e. whether the Iirm
considers as short run or a long run.
By deIinition, supply oI capital in the elastic in the short
run and elastic in the long run. In the short-run, thereIore the
Iirm can increase coal production by increasing labour only
since the supply oI capital in short run is Iixed. In the long
run, however, the Iirm can employ more oI both capital
becomes elastic over time; accordingly, there are two kinds
oI production Iunction.
i) Short run production Iunction; and
ii) Long run production Iunction
The short run production Iunction which is also
called single variable production Iunction` can be
expressed as-
Q I (L)
In the long run production Iunction, both K and L are included
and the production takes the Iorm-
Q I (K, L)

Assumptions
A production Iunction is based on the Iollowing
assumptions:-
i) PerIectly divisible inputs and output
ii) There are only two Iactors oI production labour (L) and
capital (K)
iii) Limited substitution oI one Iactor Ior the other
iv) A given technology; and
v) Inelastic supply oI Iixed Iactors in the short run.
In there is a change in these assumptions, the production
Iunction will have to be modiIied accordingly.

%0 Laws of Production

In the short-run, input-output relations are studied with one
variable input, other inputs held constant. The laws oI
production under these conditions are called 'The Laws oI
variable Proportions or 'Laws oI Return to a variable Input.
Input-output relations are studied assuming all the input to
be variable. The long run input output relation is studied under
Laws oI Return to scale.`

Law of variable of Proportions
!f one input is variable and all other raw materials are fixed the
concern's production function exhibits the law of variable
proportions. !f the number of units of a variable factor is
increased, keeping other factors constant, how output changes
is the concern of this law. As per Leftwich The law of variable
proportions states that if a variable quantity of one resource is
applied to a fixed amount of other input, output per unit of
variable input will increase but beyond some point the resulting
increases will be less and less with total output reaching a
maximum before it finally begins to decline."
Postulations
This law is based on the below postulations.
1. !t is feasible to alter the proportions in which the a range
of factors are collective
2. Only one factor is erratic while others are held invariable
3. All units of the changeable factor are standardized
4. There is no variation in expertise
S. !t presumes a short run condition
. The produce is calculated in physical units, in quintals,
tonnes etc.
7. The price of the produce is specified invariable
planation of the Law
To explain this law more clearly, let us construct a sketch.


The TP curve first rises at an enhancing rate upto point
A where its slope is highest. From point A upwards, the total
product increases at a diminishing rate till it reaches its highest
point C and then is starts falling. Point A where the tangent
touches the TP curve is called the inflection point upto which
the total product increases at an increasing rate and from
where it starts increasing at a diminishing rate.
The average product curve AP and the marginal
product curve NP also raise with TP. The NP curve reaches its
maximum point D when the slope of the TP curve is the
maximum at point A.
The maximum point on the AP curve is E where it
coincides with the NP curve. This point also coincides with
point B on the TP curve from where the total product starts a
gradual rise.
When the TP curve reaches its maximum point C, the
NP curve becomes zero at point F. When the TP starts
declining the NP curve becomes negative, i.e. is below X axis.
The rising, the falling and the negative phases of the
total, marginal and average products are in fact the different
stages of the law of variable proportions which are discussed
below.
Phase !
!ncreasing Returns - !n this stage, the average
product reaches the maximum and equals the marginal product
when 4 workers are employed which is represented in the
above diagram. This stage is portrayed here from the origin to
point E where the NP and AP curves meet. !n this stage the TP
curve also increases rapidly.
The main reason for increasing returns in the first
stage is that in the beginning the fixed factor is large in
quantity than the variable factor. When more units of the
variable factor are applied to a fixed factor, the fixed factor is
used more intensively and production increases rapidly.
!t is also explained in another way. !n the beginning
the fixed factor cannot be put to the maximum use due to the
nonadequacy of sufficient units of the variable factor. But
when units of the variable factor are applied in sufficient
quantities, division of labour and specialisation lead to per unit
increase in production and the law of increasing returns
operate.
Another reason for increasing returns is that the fixed
factor is indivisible which means that it must be used in a fixed
factor, production increases more than proportionately. This
cause points towards the law of increasing returns.
Phase !!
Law of diminishing returns - !n this stage, between
phases ! and !!! is the most significant stages of production.
Phase !! starts when the average product is at its maximum to
the zero point of the marginal product. At the latter point, the
total product is the highest. This is represented in the diagram
as the phases EB and FC. Here land is scarce and is used
intensively.
Nore and more workers are employed in order to have
larger output. Thus the total product increases at a diminishing
rate and the average and marginal products decline.
Throughout this stage, the marginal product is below product.
This is the only phase in which production is feasible and
profitable. Hence it is incorrect to say that the law of variable
proportions is another name for the law of diminishing returns.
!n fact, the law of diminishing returns is only one phase of the
law of variable proportions.
Phase !!!
Negative Narginal Returns - Production cannot take
place in the phase !!! either. For in this phase total product
starts declining and the marginal product becomes negative.
The employment of the last worker actually causes a decrease
in total output.
The dotted line represented in the diagram, FC where
the NP curve is below the x axis. Here the workers are too
many in relation to the available land making it absolutely
impossible to cultivate it. To the right of Point F, the variable
input is used excessively. Therefore production will not take
place in this stage.
Conclusion
Therefore the best stage of production is phase !!, law
of diminishing returns where the production and profitability
both are feasible. Not only that, the production is optimum in
this phase. Unlike other two phases, where the production is
impossible and hence there is no profit generated.
Thus phases ! and !!! are of economic absurdity or mere
economic nonsense. Hence no manufacturer will produce in
this phase by employing more units of the variable factor
beyond the point zero marginal products NP because there is
reduction in total product TP.
The Law of Diminishing Returns
Benham defines the law of diminishing returns as As
the proportion of one factor in a combination of factors in
increased, after a point the average and marginal product of
that factor will diminish."
!t's Application - Narshall applied the operation of this
law to agriculture fisheries, mining, forests and the building
industry. He has defined as An increase in the capital and
labour applied in the cultivation of land causes in general a less
than proportionate increase in the amount of produce raised,
unless it happens to coincide with an improvement in the arts
of agriculture."
!mportance
1. !n the words of Wick steed, the law of Diminishing returns
is an universal as the law lie itself." The universal
applicability of this law has taken economics to the realm
of science.
2. !t forms the basis of a number of a number of doctrines in
economics. The Nalthusian theory of population shoot
from the fact that food supply does not amplify rapidly
than the growth in population since the operation of the
law of diminishing returns in agriculture. !n fact this law
was responsible for Nalthus' pessimism."
3. Ricardo also based his theory of rent on this principle.
Rent arises in the Ricardian sense because the operation
of diminishing returns on land forces the application of
additional doses of labour and capital on a piece of land
does not increase output in the same proportion due to
the operation of this law.
4. Likewise, the law of diminishing marginal utility in the
theory of demand and that of diminishing marginal
physical productivity in the theory of distribution are also
based on the doctrine.
S. !n under developed countries it is of an elementary
importance for understanding their problems. !n such
economies agriculture is the main occupation of the
people. The heaviness of populace on land enlarges with
the augment in population. Consequently more and more
persons are employed on land which is a fixed factor. This
leads to declining marginal productivity of workers.

Law of R0turns to Scal0

The law of returns to scale describes the relationship between
variable inputs and output when all the inputs or factors are
increased in the same proportion. The law of returns to scale
analysis the effects of scale on the level of output. Here we find
out in what proportions the output changes when there is
proportionate change in the quantities of all inputs. The answer
to this question helps a firm to determine its scale or size in the
long run.

t has been observed that when there is a proportionate change
in the amounts of inputs, the behaviour of output varies. The
output may increase by a great proportion, by in the same
proportion or in a smaller proportion to its inputs. This
behaviour of output with the increase in scale of operation is
termed as increasing returns to scale, constant returns to scale
and diminishing returns to scale. These three laws of returns to
scale are now explained, in brief, under separate heads.

(1) Increasing Returns to ScaIe:

f the output of a firm increases more than in proportion to an
equal percentage increase in all inputs, the production is said to
exhibit increasing returns to scale.

or exampIe, if the amount of inputs are doubled and the
output increases by more than double, it is said to be an
increasing returns to scale. When there is an increase in the
scale of production, it leads to lower average cost per unit
produced as the firm enjoys economies of scale.

(2) Constant Returns to ScaIe:

When all inputs are increased by a certain percentage, the
output increases by the same percentage, the production
function is said to exhibit constant returns to scale.

or exampIe, if a firm doubles inputs, it doubles output. n
case, it triples output. The constant scale of production has no
effect on average cost per unit produced.

(3) Diminishing Returns to ScaIe:

The term 'diminishing' returns to scale refers to scale where
output increases in a smaller proportion than the increase in all
inputs.

or exampIe, if a firm increases inputs by 100% but the output
decreases by less than 100%, the firm is said to exhibit
decreasing returns to scale. n case of decreasing returns to
scale, the firm faces diseconomies of scale. The firm's scale of
production leads to higher average cost per unit produced.

raph/Diagram:

The three laws of returns to scale are now explained with the
help of a graph below:



The figure 11.6 shows that when a firm uses one unit of labour
and one unit of capital, point a, it produces 1 unit of quantity as
is shown on the q = 1 isoquant. When the firm doubles its
outputs by using 2 units of labour and 2 units of capital, it
produces more than double from q = 1 to q = 3.

So the production function has increasing returns to scale in
this range. Another output from quantity 3 to quantity 6. At the
last doubling point c to point d, the production function has
decreasing returns to scale. The doubling of output from 4 units
of input causes output to increase from 6 to 8 units increases of
two units only.
ISCUCN1S

1he Lerm isoquont" has been derlved from Lhe Creek word "
meanlng equa| and LaLln word poooto" meanlng quant|ty"
1he pooot cotve" ls Lherefore also known as pool ptoct
cotve" or ltocto lotelleoce cotve"
An lsoquanL curve ls locus of polnL represenLlng varlous
comblnaLlons of Lwo lnpuLs caplLal and labour yleldlng Lhe same
ouLpuL
lsoquanL curves are drawn on Lhe basls of Lhe followlng
assumpLlons
(l) 1here are only Lwo lnpuLs v12 labour (L) and caplLal (k) Lom
produce a commodlLy x
(ll) 1he Lwo lnpuLs L and k can subsLlLuLe each oLher buL aL
dlmlnlshlng raLe
(lll) 1he Lechnology of producLlon ls glven
Clven Lhese assumpLlons lL ls always posslble Lo produce
glven quanLlLy of commodlLy x wlLh varlous comblnaLlons of labour
and caplLal 1he facLor comblnaLlons are so formed LhaL Lhe
subsLlLuLlon of one facLor for Lhe oLher leaves Lhe ouLpuL unaffecLed
1he Lechnology ls presenLed Lhrough are lsoquanL curve (lC1 100)
1he curve lC1 all along lLs lengLh represenLs a flxed quanLlLy 100
unlLs of producL x 1hls quanLlLy of ouLpuL can be produced wlLh a
number of labourcaplLal comblnaLlons
lt exomple
olnLs A 8 C and u on Lhe lsoquanL curve lC1 shows four dlfferenL
comblnaLlons of lnpuLs k and L all yleldlng Lhe same ouLpuL 100
unlLs 1he movemenL from A Lo 8 lndlcaLes decreaslng CuanLlLy Cf k
and lncreaslng number of L 1hls lmplles subsLlLuLlon Cf labour for
caplLal such LhaL all Lhe lnpuL comblnaLlons yleld Lhe
same quanLlLy of commodlLy x le lC1 100

Character|st|cs of Isoquant Curves

a) Isoquant have a negat|ve s|ope An lsoquanL has a
negaLlve slope ln Lhe economlc reglon or ln Lhe relevanL range
1he negaLlve slope of Lhe lsoquanL lmplles subsLlLuLablllLy beLween
Lhe lnpuLs lL means lf one of Lhe lnpuLs ls reduced Lhe oLher
lnpuL has Lo be lncreased such LhaL Lhe LoLal ouLpuL remalns
unaffecLed



b) Isoquant are convex to the or|g|n ConvexlLy of
lsoquanL lmplles Lo
1 SubsLlLuLlon beLween Lhe lnpuLs
2 ulmlnlshlng marglnal raLe of Lechnlcal
subsLlLuLlon (M81S) beLween Lhe lnpuLs ln economlc reglon
1he M81S deflned as
,@$s/opeoftheisoquont
|e M81S ls Lhe raLe aL whlch a marglnal unlL of labour can
subsLlLuLe a marglnal unlL of caplLal (movlng downward on Lhe
lsoquanL) wlLhouL acLually affecLlng Lhe LoLal ouLpuL 1hls raLe ls
lndlcaLed by Lhe slope of Lhe lsoquanL 1he M81S decreases for Lwo
reasons
(|) -o facLor ls perfecL subsLlLuLe for anoLher and
(||) lnpuLs are sub[ecL Lo dlmlnlshlng marglnal reLurn
1herefore more and more unlLs of an lnpuL are
needed Lo replace each successlve unlL of Lhe
ouLpuL

c) Isoquant cannot |ntersect or be tangent to each
other 1he lnLersecLlon or Langency beLween any Lwo lsoquanL
lmplles LhaL a glven quanLlLy of a commodlLy can be produced wlLh
smaller as well as larger lnpuLcomblnaLlon 1hls ls unLenable as
long as marglnal producLlvlLy of lnpuLs ls greaLer Lhan zero

) Upper |soquant represent h|gher |eve| of output
8eLween any Lwo lsoquanL Lhe upper one represenLs a hlgher
level of ouLpuL Lhen Lhe lower one 1he reasons an upper lsoquanL
lmplles a larger lnpuL comblnaLlon whlch ln general produces a
larger ouLpuL 1herefore upper lsoquanL lndlcaLe a hlgher level of
ouLpuL

Cther types of |soquant curve

a) L|near |soquant A Llnear lsoquanL lmplles perfecL
subsLlLuLablllLy beLween Lhe Lwo lnpuLs k and L 1he lsoquanL A8
lndlcaLes LhaL a glven quanLlLy of a producL can be produced by
uslng only caplLal or only labour or by uslng boLh


1hls ls posslble only when Lwo facLors k and L are perfecL subsLlLuLes
for one anoLher A Llnear lsoquanL also lmplles LhaL Lhe M81S
beLween k and L remalns consLanL LhroughouL



b) I|xe factorproport|on or Lshape |soquant
When a producLlon funcLlon assumes a flxed proporLlon beLween k
and L Lhe lsoquanL Lakes 'L' shape Such an lsoquanL lmplles zero
subsLlLuLablllLy beLween k and L lnsLead lL assumes perfecL
complemenLarlly beLween k and L 1he perfecL complemenLarlly
assumpLlon lmplles LhaL a glven quanLlLy of a commodlLy can be
produced by one and only one comblnaLlon of k and L and LhaL
Lhe proporLlon of Lhe lnpuLs ls flxed lL also lmplles LhaL lf Lhe
quanLlLy of an lnpuL ls lncreased and Lhe quanLlLy of Lhe oLher lnpuL
ls hold consLanL Lhere wlll be no change ln ouLpuL
1he ouLpuL can be lncreaslng boLh Lhe lnpuLs proporLlonallLy


Least cost comb|nat|on ln order Lo deLermlne Lhe
besL comblnaLlon of caplLal and labour Lo produce LhaL ouLpuL
one has Lo know Lhe amounL of flnance avallable Lo Lhe
producer Lo spend on Lhe lnpuLs and also Lhe prlces of Lhe lnpuL
Suppose LhaL Lhe producer has aL lLs dlsposal 8s 10000 for Lhe
Lwo lnpuLs and LhaL Lhe prlces of Lhe Lwo lnpuLs as 8s 1000 per
unlL of caplLal and 8s 200 per unlL of labour 1he flrm wlll have
Lhree alLernaLlve posslblllLles before lL
a) 1o spend Lhe money only on caplLal and secure 10 unlLs of lL
b) 1o spend Lhe amounL only on labour and secure 30 unlL of labour
c) 1o spend Lhe amounL parLly on caplLal and parLly on labour
1he facLor prlce llne ls also known as lsocosL llne because lL
represenLs varlous comblnaLlons of lnpuLs LhaL may be purchased
for Lhe glven amounL of money allocaLed 1he slope of Lhe facLor
prlce llne shows Lhe prlce raLlo of caplLal and labour |e 1S 8y
comblnlng Lhe lsoquanL and Lhe facLor prlce llne one can flnd
ouL Lhe opLlmum comblnaLlon of facLors whlch wlll maxlmlze ouLpuL



Lqual producL curves lC
1
lC
2
and lC
3
represenLs ouLpuL of 1000
unlLs 2000 unlLs and 3000 unlLs respecLlvely A8 ls Lhe facLor prlce
llne AL polnL L Lhe facLorprlce llne ls LangenL Lo lsoquanLlC
2

represenLlng 2000 unlLs of ouLpuL olnL L lndlcaLes Lhe maxlmum
amounL of caplLal and labour whlch Lhe flrm can comblne Lo produce
2000 unlLs of ouLpuL 1he lsoquanL lC3 falls ouLslde Lhe facLor prlce
llne A8 and Lherefore cannoL be chosen by Lhe flrm
Cn Lhe oLher hand lsoquanL lC
1
wlll noL be preferred by Lhe flrm
even Lhough beLween 8 and S lL falls wlLhln Lhe facLor prlce llne
olnLs 8 and S are noL sulLable because ouLpuL can be lncreased
wlLhouL lncreaslng addlLlonal cosL by Lhe selecLlon of a more
approprlaLe lnpuL comblnaLlon olnL L Lherefore ls Lhe ldeal
comblnaLlon whlch maxlmlzes ouLpuL or mlnlmlzes cosL per unlL lL ls
Lhe polnL aL whlch Lhe flrm ls ln equlllbrlum












\))j|)j j\


GR FILD COLLG
OF GIRIG AD
%CHOLOGY


SUBMI%%D BY- MANOJ KR.
TIWARI
TARACHAND
SUBMI%%D %O- NABNITA
BARUAH
MBA 1
S%
SMS%R




CO%%

1. NATURE OF MANAGERIAL ECONOMICS
2. UTILITY THEORY
CARDINAL
ORDINAL
. SUBSTITUTION EFFECT
PRICE
INCOME
4. DEMAND ESTIMATION AND FORECASTING.
5. PRODUCTION LAWS & THEORIES
6. MARKET STRUCTURE
7. PRICING STRATEGIES & TECHNIQUES
8. MACROECONOMIC POLICIES
9. NATIONAL INCOME