Characteristics of Production Function

and Law of Diminishing Returns

Prepared By
Farzana Yeasmin
Assistant Professor
Department of Agricultural Economics
Bangladesh Agricultural University, Mymensingh-2202
 Production

• Production is defined as the creation of utility or the creation of want

satisfying goods or services. Besides, production should be defined not only
as creation of utility but also creation or addition of value.

• Production essentially means transformation of one set of goods into

another. A good may be transformed by being physically changed (form
utility) or being transported to the place of use (place utility) or being kept it
in store till required (time utility).
What is Theory Of Production ?

• In the words of Ferguson, “ The theory of production consists of how the

producer, given the state of technology combines various inputs to produce a

definite amount of output in an economically efficient manner.”

• Theory of production also seeks to explain the relationship between input and

output.
Theory of production is mainly concerned
with two things :-

1) Production Function

2) Laws of Production or Laws of Return

 Production Function

• The production function expresses a functional relationship

between quantities of inputs and outputs. It shows how and to
what extent output changes with variations in inputs during a
specified period of time.
SHORT RUN AND LONG RUN
• The short run is a time frame in which the quantities of some resources are
fixed. The long run is a time frame in which the quantities of all resources
can be changed.

• Fixed input: an input whose quantity cannot be changed in the short run.
e.g.land

• Variable input: an input whose quantity can be changed in a short period of

time. e.g. labour, raw materials etc.
Total, Average and Marginal Product

• Starting with a firms production function, we can calculate three

important production concepts: total, average and marginal product.
• Total Product (TP)
• Total product (TP) which designates the total amount of output
produced.
• It is the whole amount of output produced by all the factors
employed.
TP= Q
Average Product

• The concept of average physical product, which measures the total

output divided by total unit of input.
• Average physical product is the output per unit of the variable factor
employed.
• AP= TP/L=Q/L
Marginal Product

• The term marginal means “extra”. The marginal product of an input is

the extra product or output added by 1 extra unit of that input while
other inputs are held constant.
• The change in output resulting from employing an additional unit of
the variable factor.
• MP= ∆TP/ ∆ L= ∆ Q/ ∆ L
 Table 1: Total, Marginal and Average Product

Labour Total Product Average Product Marginal Product

(Unit) (TP) (AP) (MP)
0 0 - -
1 20 20 20
2 50 25 30
3 90 30 40
4 116 19 26
 The law of diminishing returns/ Law of variable proportion

• Using production function, we can understand one of the most famous

laws of all economics, the law of diminishing returns.

• The law of variable proportions states that as the quantity of one factor is
increased, keeping the other factors fixed, the marginal product of that
factor will eventually decline. This means that up to the use of a certain
amount of variable factor, marginal product of the factor may increase and
after a certain stage it starts diminishing. When the variable factor
becomes relatively abundant, the marginal product may become negative.
 The law of diminishing returns/ Law of variable proportion

• Law of Diminishing Returns- “If increasing amount of one input are

added to a production process while all other inputs are held
constant, the amount of output added per unit of variable input will
eventually decrease”. (Doll and Orazem, 1984)
 Assumptions of the Law of Variable Proportions

The law of variable proportions holds good under the following conditions:

• Constant State of Technology: First, the state of technology is assumed to be given and
unchanged. If there is improvement in the technology, then the marginal product may rise instead
of diminishing.

• Fixed Amount of Other Factors: Secondly, there must be some inputs whose quantity is kept fixed.
It is only in this way that we can alter the factor proportions and know its effects on output. The
law does not apply if all factors are proportionately varied.

• Possibility of Varying the Factor proportions: Thirdly, the law is based upon the possibility of
varying the proportions in which the various factors can be combined to produce a product. The
law does not apply if the factors must be used in fixed proportions to yield a product.
Three Stages of the Law of Variable Proportion:
A producer will produce a commodity with the varying quantity of one factor is combined with a fixed quantity
of others. He will divide the whole production system into three stages. In order to understand these three
stages it is better to tabular and graphically illustrates the production function with one factor variable.

Suppose there is a given amount of land in which more and more labour (variable factor) is used to produce
wheat.

The production function is: Y= f (X1| X2, X3……….Xn)

There, Y= Output, X1= One variable factor, X2, X3……….Xn= Fixed variables.

In the figure, on the X- axis is measured the quantity of variable factor and the Y-axis are measured the total
product (TP), average product (AP) and marginal product (MP). How TP, AP and MP change as a result of the
increase in quantity of variable input. It will see in table-1 and Figure-1.
 Average Product Marginal Product Stages of
Inputs (X1) Total Product (Y1) (∆#$
(Y1/X1) !∆%$) Production

0 0 - -
1 5 5 5
I
2 14 7 9
3 21 7 7
4 26 6.5 5
5 30 6 4
6 33 5.5 3
II
7 35 5 2
8 36 4.5 1
9 36 4 0
10 35 3.5 -1
III
11 33 3 -2
Three Stages of the Law of Variable Proportions:
These stages are illustrated in the following figure where labour is measured on the X-axis and output on the Y-
axis.

• Figure-1: Total, Average and Marginal Product and the regions of Production
Stage 1. Stage of Increasing Returns:
• In this stage, total product increases at an increasing rate up to a point. This is because the
efficiency of the fixed factors increases as additional units of the variable factors are added to it.
In the figure, from the origin to the point F, slope of the total product curve TP is increasing i.e.
the curve TP is concave upwards up to the point F, which means that the marginal product MP of
labour rises. The point F where the total product stops increasing at an increasing rate and starts
increasing at a diminishing rate is called the point of inflection. Corresponding vertically to this
point of inflection marginal product of labour is maximum, after which it diminishes. This stage is
called the stage of increasing returns because the average product of the variable factor increases
throughout this stage. This stage ends at the point where the average product curve reaches its
highest point.
Stage 1. Stage of Increasing Returns:
• In this stage, total product increases at an increasing rate up to a point. This is because the
efficiency of the fixed factors increases as additional units of the variable factors are added to it.

• In the figure, from the origin to the point F, slope of the total product curve TP is increasing i.e.
the curve TP is concave upwards up to the point F, which means that the marginal product MP of
labour rises. The point F where the total product stops increasing at an increasing rate and starts
increasing at a diminishing rate is called the point of inflection.

• Corresponding vertically to this point of inflection marginal product of labour is maximum, after
which it diminishes. This stage is called the stage of increasing returns because the average
product of the variable factor increases throughout this stage. This stage ends at the point where
the average product curve reaches its highest point.
 Zone I/ Stage I
• TP increases at an increasing rate up to point F. Beyond this point, total product
curve goes on rising but at a declining rate.
• At point F, where total product curve stops increasing at an increasing rate and
starts increasing at the diminishing rate is called the point of inflexion.
• MP is maximum at the point of inflexion.
• AP is increasing
• MP>AP
• At the border between zones I and II AP is at a maximum and AP=MP
• Elasticity of response >1
• It is irrational to produce zone I since by adding inputs a greater than proportional
increase in output is obtained. Thus it is better to produce in zone II.
Stage 2. Stage of Diminishing Returns:
• In this stage, total product continues to increase but at a diminishing rate
until it reaches its maximum point H where the second stage ends. In this
stage both the marginal product and average product of labour are
diminishing but are positive. This is because the fixed factor becomes
inadequate relative to the quantity of the variable factor. At the end of the
second stage, i.e., at point M marginal product of labour is zero which
corresponds to the maximum point H of the total product curve TP. This
stage is important because the firm will seek to produce in this range.
Zone II/ Stage II
• TP is increasing at a diminishing rate.
• AP is decreasing but positive
• MP is decreasing but positive
• AP>MP
• Elasticity of response is greater than zero and less than 1.
• Diminishing returns with respect to variable input.
• Rational zone of production. At the border between zone I and III TP
is at maximum. i.e, MP=0
Stage 3. Stage of Negative Returns:

• In stage 3, total product declines and therefore the TP curve

slopes downward. As a result, marginal product of labour is
negative and the MP curve falls below the X-axis. In this
stage the variable factor (labour) is too much, relative to the
fixed factor.
Zone III/ Stage III
• TP is positive but declining
• AP is positive but AP>MP
• MP is negative.
• Elasticity of response is less than zero/irrational as MP<0
Where will a rational produce operate his production? /In which stage,
the producer will choose for operation?

The producer will never choose the 3rd stage to produce where MP of variable factor is
negative. Because, he can always increases his output by reducing the amount of variable
factors.

A rational producer will also not choose to produce in stage 1 where marginal product of
the fixed factor is negative. A producer producing in stage 1 means he will not be utilizing
fully the opportunities of increasing production by increasing quantity of variable factor
whose AP continues to rise throughout the stage 1. Thus the producer will not stop in stage
1 but he will expand further. Even if the fixed factor is free, only at the end of stage 1 (at
point N).
Where will a rational produce operate his production? /In which stage,
the producer will choose for operation?

• It is clear that the rational producer will not choose to produce in stage 1 and 3.
Thus stage 1 and 3 express the non-economic region in production function.

• A rational producer will always want to produce in stage 2 where both MP and AP
of variable factor are diminishing. The stage 2 represents the range of rational
production decision.

• Now we can say that this input-output relationship divides into three stages:
Stage 1 of increasing returns, stage 2 of diminishing returns and stage 3 of
negative return.
Causes of Applicability
Causes of increasing returns to a factor :
• 1.Fuller utilization of the fixed factor : In the initial Stages fixed factor
remains under utilized. Its fuller utilization cause for greater application of
the variable factor. Hence initially additional units of the variable factor add
more & more to total output .
2. Increased efficiency of the variable factor : Additional application of the
variable factor causes process based division of labour that raises efficiency
of the factor. Accordingly MP of the factor tends to Rise.
Causes of decreasing return to a factor :

1. Fixity of the factor: as more & more units the variable factor continue to be combined

with the fixed factor , the latter gets over utilized. Hence the diminishing returns.

2. Imperfect factor substitutability: factors of production are

• imperfect substitutes of each other. more & more of labour cannot be continuously used

in place of additional capital.

 Applicability of the law of Variable
Proportion
• Law of variable proportions applies to all fields of production, like agriculture,

industry, etc. This law applies to any field of production where some factors are

fixed and other are variable. That is the reason, why it is called law of universal

application.

• vApplication to Agriculture

• vApplication to Industry