ECONOMICS

ASSIGNMENT-2

VASUDHA KABRA 08/10/2020 Thursday

Ques 1. Explain Law of diminishing returns with the help of graph. Discuss that this law is
a universal Law.
Ans 1. The Law of Diminishing Returns is also known as The Law of Variable Proportions.
Law of diminishing returns explains that when more and more units of a variable input are
employed on a given quantity of fixed inputs, the total output may initially increase at increasing
rate and then at a constant rate, but it will eventually increase at diminishing rates.

Assumptions:
 Only one input/factor should be variable. Keeping other inputs constant.
 It is assumed that the state of technology does not change.
 Units of the variable inputs/factors are equally efficient.

The Three Stages of Production:

I. Stage 1: Increasing returns- Initially, adding to one production variable is likely to

improve the output, as the fixed inputs are in abundance compared to the variable one.
Therefore, adding more units of the variable factor will use the fixed factors more
efficiently and increase production.
II. Stage 2: Diminishing returns- As more units of the variable factor are added, the overall
production will continue to increase. However, during this stage, the total product
increases at a continuously decreasing rate. This process culminates with the product
reaching its maximum value, meaning that the MP becomes zero. Optimum production
is set somewhere within this stage. Adding more units of the variable factor after this
point will lead to the overall output starting to diminish.
III. Stage 3: Negative returns- Excessively adding to the variable input after the point of
optimum production will eventually lead not only to a decrease in efficiency but even to
a negative return of production. The excess in the variable factor now has a negative
effect on the whole production process.

“Hence, the Law of diminishing returns is a universal Law, it operates in all economies,
more developed or less developed.”
Ques 2. When does production indicates increasing returns to scale?

Ans 2. The term returns to scale refers to the changes in output as all factors change by the same
proportion. Returns to scale is the variation or change in productivity that is the outcome from a
proportionate increase of all the input. An increasing return to scale occurs when the output increases
by a larger proportion than the increase in inputs during the production process. For example, if input
is increased by 3 times, but output increases by 3.75 times, then the firm or economy has experienced
an increasing return to scale. When increasing returns to scale occurs, it results in economies of scale.
This is owing to the fact that efficiency increases when organizations progress from small-scale to
large-scale production.

Thus, we can say that the production of shoes obeys the Law of Increasing Returns. This law is also
known as the Law of Diminishing Costs. It means cost per unit of the extra output falls as the industry
expands.

Ques 3. Why Stage II is termed as rational decision stage.

Ans 3. The Stage II is termed as rational decision stage as:

 the fact that this stage it comes out with the best assumptions for efficient and
sustainable production, thereby the stage it simultaneously shows the positivity of
the AP and MP hence, in the increase of labour the total production or outputs
increased likewise with the same quantity of fixed factor, therefore this stage it
gives direction to the producer on how the higher units of output can be produced.
 Unlike the first stage to which it shows each additional variable could enhance
more production and such this it signifies an increasing of marginal return but for
this case it do not give out the direction in permanent production since labours are
needed fewer and in the decrease in number of labour can brings about
underproduction.
 Also the third stage marginal return is negative because in adding more variable
inputs will further led into adding more number of labour hence the increase of
labour will contributes to under production as it may be due to labour capacity and
efficiency concern.
 Thus, this stage is rational because producer rationally choses what benefits for his
production such that it doesn’t contribute to loses. A producer will find his
equilibrium only in II stage of production when MP is declining but remains
positive.
Ques 4. Role of Economics with demand forecasting.

Ans 4. According to Henry Fayol, “the act of forecasting is of great benefit to all who take part in the
process and is the best means of ensuring adaptability to changing circumstances .
Economics play a crucial role in obtaining demand forecasts. For example, if there is a positive
development in an economy, such as globalization and high level of investment, the demand forecasts
of organizations would also be positive.

 Demand forecast can be prepared on various levels, which includes level of ECONOMY:
The entrepreneurs can have their own forecasts based upon total national output or gross
national product
 Types of demand forecasting on the basis of:
i. Firm (micro) Level – forecasting from the manager’s point of view to take decisions
relating production and marketing.
ii. Economy (macro) Level – forecasting of aggregate demand in the economy as a whole.
iii. Industry level – provides an insight into the relative contribution of the industry in
national income.
iv. Short term forecasting – helps in taking decision regarding inventory, cost of variable
factors and sales target.
v. Long term forecasting – helps in manpower planning, long term capital required, and
investment decisions.