Production Function: Laws of Returns or Returns to a factor

Production in economics is defined as transformation of input into output. Production

includes physical goods & services both
Inputs in economics are known as factors of production these can be classified under 2
heads:

1. Fixed factors: - fixed factors of production are those which factor inputs cannot
be changed at different levels of output in the short period. Eg: land, machinery
etc.

2. Variable Factor: - Variable factor inputs are those whose quantity will differ at
different levels of output .even in the short run. Eg : Labour, Raw material etc.

Difference between variable factors and fixed factors”

basis Variable factors Fixed factors
Meaning Those factors which can Those factors which cannot be
be changed in the short changed in the short run
run
Relation with They vary directly They do not vary directly without
output without put put
Example Raw material, casual Building, plant and machinery,
labour, power, fuel permanent staff

There are 2 time periods under which production takes place.

1) Short Run: Some factor inputs are fixed while others are variable. The
production in short run can be increased only by increasing quantity of
variable factors.
2) Long Run: All factors of production become variable the distinction between
fixed & variable factor become irrelevant. The production in long run can be
increased by increasing all the factors of production.
Difference between Short run and Long run

basis Short run Long run

Meaning Short run refers to a period in which
output can be changed by changing
only variable factors.
Classification Factors are classified as variable
and fixed
Factor in the short run.
Price In the short run, demand is more
determinatio active in price determination as
n supply cannot be increased
immediately with increase in
demand
Long run refers to a period in which
output can
be changed by changing all factors
of production.
All factors are variable in the long run.
In the long run, both demand and
supply play equal role In price
determination as both can be
increased.

. PRODUCTION FUNCTION:
Production function means functional relationship between inputs used &
resulting output
OR
Production function is an expression of the technological relation between
physical inputs and output of a good.
Qx = f (L, Land, K , E)
The main features of a production function are as follows:
1. It is a physical Technical relationship
2. It is determined by the state of technology.

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 3. Production function is expressed with reference to a particular period of time.
. There are 2 types of production function

1) Short Run Production function: It refers to production in the short run

where some factors remain fixed & others variable. In short run. Product
increases when more units of variable factors are used with the fixed factors.
This is known as returns to a variable factors or law of variable proportions
Qx = f ( labour, K¯)
2) Long Run Production function: It refers to production in a time period when
all factors are variable. It describes the behavior of output when all inputs are
changed in the same proportion. It is the subject matter of returns to scale.
Qx = (L,K)

CONEPTS OF PRODUCT
1) Total product / Total physical product :- It is defined as the total
quantity & services produced by a firm with the given inputs during a
specified period of time or total product is sum total of output of each
unit of variable factor used in the process of production. Thus
TP = Sum of MPs
TP = AP X L
2) Marginal Product :- is a net addition to total product when one more
unit of variable factors employed
MP = TPn- TPn-1
MP = ∆TP
∆L
3) Average. product :- is the per unit production of the variable factors
i.e.
AP = TP
L

Fixed Variable TP AP MP
Factor Factor TP TPn – TPn-1
(Land) L

10 0 0 0 0

10 1 4 4 4

10 2 4 + 6 = 10 5 6 (10 - 4)

10 3 10 + 8= 18 6 8 (18 -10)

10 4 18 + 6 = 24 6 6 (24 -18)

10 5 24 + 4 = 28 5.6 4 (28 - 24)

10 6 28 4.6 0 (28 – 28)

10 7 28 – 8 = 20 2.8 - 8 (20 – 28)

10 8 20 – 4 = 16 2 - 4(16 – 20)

Relationship between TP & MP

1. When MP increases , TP increases at increasing rate .

2. When MP starts decreasing but remains positive then TP decreases at decreasing

rate.

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 3. When MP is O (zero) TP is maximum & constant

4. When MP is negative,TP begins to fall

Relationship between AP & MP

1. Both AP & MP cures are derived from TP since, AP = TP & MP = ∆TP
L ∆L
2. When MP is greater than AP, AP rises but MP rises at faster pace.
3. When MP equals to AP, AP is constant
4. When MP is less than AP, AP falls but MP falls at higher rate.

T
A

Total product

TP

Point of inflexion

O L1 L2 L3 Unit of labour X

Stage I Stage II Stage III

Average and M.P. M A

AP

O L1 L2 L3 Units of labour X

MP

Law of variable proportions or Returns to factor

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It states that as more & more units of a variable factor are applied to a given quantity of a
fixed factor the total product may increase at an increasing rate initially but eventually it will
increase at a diminishing rate.
Assumptions
1. The law applies only in the short run.
2. One factor of production is variable & others are fixed.
3. All units of variable factor are homogeneous.
4. State of technology is given & remains the same.
5. Factor proportions can he changed.
6.
Table of TP, AP, MP along with the graph showing 3 stages of Low of variable
proportion

There are 3 stages of law of Variable proportions

1. Increasing returns to a factor :- In this stage, TP increase at increasing rate & later
at the diminishing rate.
AP increases & reaches at its maximum
MP initially increases then starts decreasing but continues to remain above AP
2. Diminishing Returns to a factor :- TP increases at a diminishing rate till it reaches
at maximum point & then becomes constant
AP continues to fall
MP decreases & finally becomes zero (o).
3. Negative Returns to a factor :- TP begins to fall AP continues to fall but remains
positive
MP becomes negative
Causes of 3 stages of Law of variable proportion .
1. Increasing return to a factor:- In the first phase every additional variable factor
adds more and more to the total output.
(i) Fuller utilization of fixed factor : In the initial stages Fixed factor remain
under utilized its fuller utilization starts with the more application of variable
factor, hence, initially additional unit of variable factors add more to the total
output

(ii) Specialization of Labour / Division of labour :- Additional application of

Variable factor causes process based division of Labour that raises the
efficiency of factors. Accordingly marginal productivity tends to rise.

3. Diminishing return to a factor:-In this phase every additional variable factor

adds lesser and lesser amount of output.
(i) Imperfect factor substitutability: - Factors of production are imperfect
substitutes of each other. More & more of Labour, for example. Cannot be
continuously used in place of additional capital. Accordingly diminishing
returns to variable factor becomes inevitable.

(ii) Disturbing the optimum proportion: - Continuous increase in application of

variable factor along with fixed factors beyond a point crosses the limit of
ideal factor ratio. This results in poor co-ordination between the fixed &
variable factors which causes diminishing return to a factor.

4. Negative returns to a factor :- In this phase the employment of additional

variable factor causes TP to decline.
(i) Overcrowding :- When more & more variable factors are added to a given
quantity of fixed factor it will lead to over crowding & due to this MP of the
Labours decreases & it goes into negative

(ii) Management Problems: - When there are too many workers they may shift
the responsibility to others & it becomes difficult for the management to
coordinate with them. The Labours avoid doing work. All these things lead to

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 decrease in efficiency of Laboures. Thus the output also decreases.

In which stage should a producer operate?

A rational producer would always prefer to operate in the 2nd stage. He will not stay in Ist
stage because it is the stage of increasing returns. Employment of every additional unit of
variable factor gives more and more of output i.e. marginal product increases. It means there
is scope for more profits, if production is increased with more units of variable factors.

He will also not operate under 3rd stage where the total product starts decreasing. Marginal
product for each variable factor is negative. So this phase is ruled out on the basis of
technical inefficiency and a rational producer will never produce in the third phase.

The 1st & 3rd stages are called stages of economic absurdity hence a rational producer would
like to operate in 2nd stage because it is the stage where AP & MP of variable factors are
declining but remain positive and TP increases and becomes maximum in this stage only.
Thus this is the best stage to work.

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