In This Lecture… Concepts of Production Factors of Production Production Function with One Variable Input – Law of Variable Proportion Concepts of Total, Average and Marginal Products

Production Production is the transformation of inputs into output. Production creates utility.

Production Function Production function is the technical relationship between physical inputs and physical output. Q = f (L,K) where, Q = output L = labor K = capital 4

Types of Production Function Short-run Production Function : It refers to the production in the short run where there are some fixed factors. Long-run Production Function : It refers to the production in the long run where all the factors are in variable supply. 5

Concepts of Product : Total Product I Total Product (TP) or Total Physical Product (TPP) is the total quantity of goods and services produced by a firm with the given inputs during a specific time period. In the short run TP can be increased by employing more units of variable factor. In the long run TP can be increased by employing more of all factors. 6

Concepts of Product : Total Product II Total Product (TP) schedule Units of Labor (L) Total Product (TP) 1 2 3 4 5 6 7 8 10 18 24 28 30 7

Concepts of Product : Total Product III Total Product Curve TP TP curve starts from the origin, increases at an increasing rate , then TP increases at a decreasing rate reaches a maximum and after that it starts falling. 0 Units of labor 8

Concepts of Product : Average Product I Average Product (AP) or Average Physical Product (APP) is the amount of output produced per unit of a variable factor during a specific time period. Symbolically, AP = Total Physical Product = TPP Labor Input L 9

Concepts of Product : Average Product II Average Product (AP) schedule L TP AP 1 2 3 4 5 6 7 8 10 18 24 28 30 5.6 4.3 3.5 10

Concepts of Product : Average Product III Average Product Curve AP TP curve starts from the origin, increases at an decreasing rate , reaches a maximum and after that it starts falling. As long as TP is AP positive AP is positive. 0 Units of labor 11

Concepts of Product : Marginal Product I Marginal Product (MP) or Marginal Physical Product (MPP) is the change in Total Physical Product due to the change in employing one extra unit of a variable factor. Symbolically, AP = Change in TPP = ΔTPP Changre in Labor Input ΔL 12

Concepts of Product : Marginal Product II Marginal Product (MP) schedule L TP MP 1 2 3 4 5 6 7 8 10 18 24 28 30 - -2 13

Concepts of Product : Marginal Product III Marginal Product Curve MP MP curve starts from the origin, increases initially reaches a maximum and starts falling and becomes negative. When TP is maximum MP is zero. 0 Units of labor MP 14

Relationship between TP, AP, MP 0 Variable factor (labor) AP/MP AP 0 Variable factor (labor) MP When AP is maximum, MP=AP (v) AP and MP are inverted When TP is maximum MP=0 U-shaped curve When TP is falling MP is negative (vi) MP cuts AP at its max point As long as TP is positive AP is positive and at that point MP=AP 15

Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product I Law of Variable Proportion is widely observed law of production that takes place in short run. Law of Variable Proportion states that as we combine more and more of the variable factor along with the fixed factor, TP initially increases at an increasing rate, then at diminishing rate and then at a negative rate. 16

Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product II Law of Diminishing Marginal Product states that as we combine more and more of the variable factor along with the fixed factor, eventually a point will be reached after which the marginal product of that input start falling. The classical economists called it the Law of Diminishing Returns. They derived it by applying more and more labour to a fixed acreage of land, and thought of it as associated particularly with agriculture. But it is a general principle that can be applied to any production operation. It is now usually called the Law of Variable Proportions. It can also be called the Law of Diminishing Marginal product or Diminishing Marginal Returns or simply as Diminishing Returns. 17

Assumptions of the Law:- (i) State of technology is constant. Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product III Assumptions of the Law:- (i) State of technology is constant. (ii) All units of the variable factor are homogenous. (iii)There must always be some fixed input. 18

Three Stages of Production under the Law:- Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product IV Three Stages of Production under the Law:- (i) Stage of Increasing Returns (ii) Stage of Diminishing Returns (iii) Stage of Negative Returns 19

Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product V 20

Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product VI 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 labor 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 labor 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. 21

Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product VII Stage of Decreasing 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 labor are diminishing but are positive. This is because the fixed factor has its optimal use at this stage and 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 labor 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. 22

Stage of Negative Returns :- Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product VIII Stage of Negative Returns :- In stage 3, total product declines and therefore the TP curve slopes downward. As a result, marginal product of labor is negative and the MP curve falls below the X-axis. In this stage the variable factor (labor) is the over utilization of the fixed factor. 23

Importance and Applicability of the Law of Variable Proportion:- Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product IX-A Importance and Applicability of the Law of Variable Proportion:- The Law of Variable Proportion has universal applicability in any branch of production. It forms the basis of a number of doctrines in economics. The Malthusian theory of population stems from the fact that food supply does not increase faster than the growth in population because of the operation of the law of diminishing returns in agriculture. 24

Importance and Applicability of the Law of Variable Proportion:- Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product IX-B Importance and Applicability of the Law of Variable Proportion:- Ricardo also based his theory of rent on this principle. According to him rent arises because the operation of the law of diminishing return forces the application of additional doses of labor and capital on a piece of land. Similarly the law of diminishing marginal utility and that of diminishing marginal physical productivity in the theory of distribution are also based on this theory. 25

Importance and Applicability of the Law of Variable Proportion:- Returns to a Factor-Law of Variable Proportion and Law of Diminishing Marginal Product IX-C Importance and Applicability of the Law of Variable Proportion:- The law is of fundamental importance for understanding the problems of underdeveloped countries. In such agricultural economies the pressure of population on land increases with the increase in population. This leads to declining or even zero or negative marginal productivity of workers. This explains the operation of the law of diminishing returns in LDCs in its intensive form. Ragnar Nurkse have suggested ways to make use of these disguisedly unemployed labor by withdrawing them and putting them in those occupations where the marginal productivity is positive. 26