g

e
h
T
c
u
d
o
r
p
C
i
n
m
O
v
S
t
,
a
f
d
o
L
s
i
p
a
C
h
c
e
T
n
I
O
t
u
ti
b
y
g
l
Production:

Fixed Inputs:
PRODUCTION FUNCTION:

 Production means transforming inputs (Labour, Machines, Raw materials etc.) into an output.

 “Production is the process by which the resources (input) are transformed into a different and
more useful commodity. Various inputs are combined in different quantities to produce various
levels of output.”

 It is the process in which the inputs are converted in to outputs.

INPUT
PRODUCTION

PROCESS

E.g., Buildings, major capital equipments and managerial personnel.

Variable Inputs:

Short Run:
OUTPUT

•A fixed input is defined as one whose quantity cannot be changed instantaneously in response to
changes in market conditions requiring an immediate change in output.

•A variable input is one whose quantity can be changed readily when market condition suggests
that an immediate change in output is beneficial to the producer.
E.g. raw materials and labour services.

•The short run is that period of time in which quantity of one or more inputs remains fixed
irrespective of the volume of output.
•Therefore, if output is to be increased or decreased in the short run, change exclusively in the
quantity of variable inputs is to be made.

Long Run:
•Long run refers to that period of time in which all inputs are variable.
1|Page
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR
•Thus, the producer does not feel constrained in any way while changing the output.
•In the long run it is possible for the producer to make output changes in the most advantageous way.

Production Function:

 Production function is defined as “the functional relationship between physical inputs

( i.e., factors of production ) and physical outputs, i.e., the quantity of goods produced”.

 “A production function refers to the functional relationship, under the given technology,
between physical rates of input and output of a firm, per unit of time.”

 Production function means the functional relationship between inputs and outputs in the
process of production.

 It is a technical relation which connects factors inputs used in the production function and
the level of outputs

Production function may be expressed as under:

Q = f ( K, L)

Where;
Q = Output of commodity per unit of time.
K = Capital.
L = Labour.
f = Functional Relationship.

Production function depends on:

 Quantities of recourses used.

 State of technical knowledge.

 Possible process.

 Size of firms.

 Relative prices of factors of production.

 Combination of factors.

Laws of Production

Laws of production are of two types:

 The law of variable proportions.

 Laws of returns to scale.

2|Page
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR
 THE LAW OF VARIABLE PROPORTIONS

This law is one of the most fundamental laws of production. It gives us one of the key insights to
the working out of the most ideal combination of factor inputs. All factor inputs are not available
in plenty. Hence, in order to expand the output, scarce factors must be kept constant and variable
factors are increased in greater quantities. Additional units of a variable factor on the fixed factors
will certainly mean a variation in output. The law of variable proportions or the law of non-
proportional output will explain how variation in one factor input give place for variations in
outputs.

The law of variable proportions is the new name for the famous “Law of Diminishing Returns” of
classical economists. This law is stated by various economists in the following manner:-

According to Prof. Benham, “As the proportion of one factor in a combination of factors is
increased, after a point, first the marginal and then the average product of that factor will
diminish”.

The same idea has been expressed by Prof. Marshall in the following words “An increase in the
quantity of a variable factor added to fixed factors, at the end results in a less than proportionate
increase in the amount of product, given technical conditions.”

Assumptions:

The law of variable proportions also called the law of diminishing returns holds good under the
following assumptions:
(i) Short run. The law assumes short run situation. The time is too short for a firm to change the
quantity of fixed factors. All the, resources apart from this one variable, are held unchanged in
quantity and quality.
(ii) Constant technology. The law assumes that the technique of production remains unchanged
during production.
(iii) Homogeneous factors. Each factor unit in assumed to the identical in amount and quality.
(iv) The law is based on the possibility of varying the proportions in which the various factors can
be combined to produce a product.
KEY TERMS/CONCEPTS IN PRODUCTION ANALYSIS:

 Total product (TP): The total amount of output resulting from a given production
function.

 Average product (AP): Total product per unit of given input factor.

AP = TP/L

 Marginal product (MP): The change in total product per unit change in given input
factor.

MP = ΔQ/ ΔL = ΔTP/ ΔL= dQ/dL = dTP/dL

3|Page
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR
EXPLANATION OF THE LAW WITH EXAMPLE:

A hypothetical production schedule is worked out to explain the operation of the law.
Fixed factors = K which is 5 units capital. Variable factor = labor = L

No .of workers with TP AP =TP/L ΔTP STAGES OF

MP =
fixed capital ratio ΔL PRODUCTION
L:K

0:5 0 0 0 STAGE-I
1:5 8 8 8 INCREASING
RETURNS
2:5 20 10 12
3:5 36 12 16
4:5 48 12 12
5:5 55 11 8 STAGE-II
6:5 60 10 5 DIMINSHING
RETURNS
7:5 60 8.6 0

8:5 56 7 -4 STAGE-III
NAGATIVE
9:5 45 5 -11 RETURNS

DAIGRAMATIC PRESENTATION: EITHER OR DAIGRAM

STAGE 1- THE LAW ON INCREASING RETURNS

4|Page
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR
  TP increases at an increasing rate up to a point F.
 MP also rises and is maximum at point F.
 AP goes on rising.
 After point F, TP rises but at diminishing rate.
 MP falls but is positive.
 Stage 1 ends where AP reaches its highest point.

The I stage is called as the law of increasing returns on account of the following reasons.

1. The proportion of fixed factors is greater than the quantity of variable factors. When the
producer increases the quantity of variable factor, intensive and effective utilization of fixed
factors become possible leading to higher output.
2. When the producer increases the quantity of variable factor, output increases due to the
complete utilization of the “Indivisible Factors”.
3. As more units of the variable factor is employed, the efficiency of variable factors will go up
because it creates more opportunity for the introduction of division of labor and specialization
resulting in higher output.

STAGE 2- THE LAW OF DIMINSHING RETURNS

 TP continues to increase at a diminishing rate, until it reaches it maximum point H.

 Both MP and AP continuously fall during this stage.
 Stage ends when TP reaches its maximum point H.

Diminishing returns arise due to the following reasons:

1. The proportion of variable factors is greater than the quantity of fixed factors. Hence, both AP
& MP decline.
2. Total output diminishes because there is a limit to the full utilization of indivisible factors and
introduction of specialization. Hence, output declines.
3. Diseconomies of scale will operate beyond the stage of optimum production.
4. Imperfect substitutability of factor inputs is another cause. Up to certain point substitution is
beneficial. Once optimum point is reached, the fixed factors cannot be compensated by the
variable factor. Diminishing returns are bound to appear as long as one or more factors are fixed
and cannot be substituted by the others.

SATGE -3 THE STATE OF NAGATIVE RETURNS

 TP declines.
 MP negative.
 AP is diminishing

REASONS OF NGATIVE RETURNS

5|Page
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR
In this case, as the quantity of variable input is increased to a given quantity of fixed factors,
output becomes negative. During this stage, TP starts diminishing, AP continues to diminish and
MP becomes negative. The negative returns are the result of excessive quantity of variable factors
to a constant quantity of fixed factors. Hence, output declines. The proverb “Too many cooks
spoil the broth” and “Too much is too bad” aptly applies to this stage. Generally, the III stage is a
theoretical possibility because no producer would like to come to this stage.

The producer being rational will not select either the stage I
(because there is opportunity for him to increase output by employing more units of variable
factor) or the III stage (because the MP is negative). The stage I & III are described as NON-
Economic Region or Uneconomic Region. Hence, the producer will select the II stage (which is
described as the most economic region) where he can maximize the output. The II stage
represents the range of rational production decision. According to the Joan Robinson
“Increasing returns is the empirical fact where as diminishing returns is the logical
necessities.”

PRACTICAL APPLICATION OF THE LAW/SIGNIFICANCE/APPLICATION OF LAW

OF VARIABLES PROPERTION
1. It helps a producer to work out the most ideal combination of factor inputs or the least cost
combination of factor inputs.
2. It is useful to a businessman in the short run production planning at the micro-level.
3. The law gives guidance that by making continuous improvements in science and technology,
the producer can postpone the occurrence of diminishing returns.
4. It is helpful in understanding clearly the process of production. It explains the input output
relations. We can find out by-how much the total product will increase as a result of an increase in
the inputs.
5. The law tells us that the tendency of diminishing returns is found in all sectors of the economy
which may be agriculture or industry.

THE LAWS OF RETURNS TO SCALE

 The laws of returns to scale explain the behavior of output in response to a proportional
and simultaneous change in inputs. Increasing inputs proportionately and simultaneously
is, in fact, an expansion of the scale of production.
 “Return to scale refers to the relationship between changes of outputs and proportionate
changes in the in all factors of production ”
 Long run refers to that time in the future when all inputs are variable inputs.

6|Page
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR
  Output can be varied by changing the levels of both L & K and the long run production
function is expressed as:
Q = f (L, K)
When a firm increases both the inputs proportionately, there are three possibilities
1. Total output may increase more than proportionately
2. Total output may increase proportionately
3. Total output may increase less than proportionately
Accordingly, there are three kinds of return to scale
1. Increasing returns to scale
2. Constant returns To Scale
3. Decreasing returns to scale

SOME CONCEPT IN RETURN TO SCALE:

ISOQUANTS:
 An isoquants represent all those possible combination of two inputs (labour and capital),
which is capable to produce an equal level of output.
 It represents all possible input combinations of the two factors, which are capable of
producing the same level of output.
 This is also known as Iso-Product curve, Equal-Product curve or Production
Indifference curve.

Combination Labour Capital Output level

A 20 1 100 unit

B 18 2 100 unit

C 12 3 100 unit

D 9 4 100 unit

E 6 5 100 unit

F 4 6 100 unit

7|Page
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR
 Isoquants or equal product curve

Capital

100 unit output

Labour

Marginal Rate Technical Substitute(MRTS):

The slop of isoquant is known as Marginal Rate of Technical Substitution (MRTS). It is the rate at
which one factors of production is substitute with other factor so that the levels of the output
remain the same.
 MRTS of L for K is defined as the quantity of K which can be given up in exchange for an
additional unit of L, so that level of output remains the same.

MRTS = Changes in Labour / changes in capital

ΔK
MRTS=| |
ΔL

Decreasing returns to scale

INCREASING RETURNS TO SCALE

8|Page
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR
  The law of increasing returns to scale implies that output increases more than
proportionately to the increase in input and the rate of increase in output goes on
increasing with each subsequent increase in input.

It shows that output doubles itself even before the inputs can be doubled. In the following figure that the
units of labour are measured on X-axis and units of capital on Y axis. The scale line OA/OB is drawn which
shows the expansion path of a firm. In this case the distance between every successive isoquants
becomes smaller and smaller i.e. OA > AB > BC.

Diagram

In case of increasing returns to scale, the production function is homogeneous of degree greater than one.
Example: 
10 units (IQ1 at A) = 1L+ K 
25 units (IQ2 at B) = 2L + K 
35 units (IQ3 at C) = 3L + 3K
Causes of Increasing Returns to Scale: 
a. Internal economies of scale 
b.Efficiency of labour and capital 
c.Improvement in large scale operation 
d.Division of labour and specialization 
e.Use of better and sophisticated technology 
f.Economy of organisation 
g.External economies of scale
CONSTANT RETURNS TO SCALE:

 There are constant returns to scale when a given percentage increase in input leads to an equal percentage
increase in output. It shows that if inputs are doubled then the output also gets doubled. If inputs are trebled
then the output also trebles

9|Page
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR
  Symbolically:

 Where

 Proportionate Change in input =proportionate change in output

In figure it is assumed that, in the production of the good, only two factors, labor and capital are
used. The straight ling passing through the origin indicate the increase in scale as we move
upward. It is seen from the figure that successive isoquants are equidistant from each other along
the straight line drawn from the origin. The distance between the successive equal product curves
being the same along the straight line through the origin means that if both labor and capital are
increased in a given proportion, output expands by the same proportion. Thus this figure display
constant return to scale Where OA=AB=BC.

Causes of Constant Returns to Scale:

a) Internal economics of scale are equal to internal diseconomies of scale.

b) Balancing of external economics and diseconomies of scale
c) Factors of production are perfectly divisible substitutable, homogenous and their supply is
perfectly elastic at given prices.
DECREASING RETURNS TO SCALE:
The firms are faced with decreasing returns to scale when a certain proportionate change in
inputs, k & l, lead to less than proportionate change in output.
There are decreasing returns to scale when a given percentage increase in input leads to a smaller
percentage increase in output.

10 | P a g e
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR
In given figure successively decreasing return to scale occur since OA<AB<BC.It means that
more and more of input are required to obtain equal increase in output.
Causes of Diminishing return to scale

 Internal diseconomies of scale

 External diseconomies of scale
 Increase in business risk
 Lack of entrepreneurial efficiency
 Unhealthy management and organization
 Imperfect factor substitutability
 Transport bottlenecks and Marketing difficulties.
Conclusion:
We can say that laws of returns to scale are a matter of interaction between economies and
diseconomies of large scale production. Initially when a firm expands, it faces increasing
returns to scale because of the scale economies. As the scale of operation rises, increasing
return to scale give way to constant returns to scale, because here economies and
diseconomies of large scale production balance each other. But if the firm continues to
expand its scale of production beyond a point, it experiences diminishing returns to scale.
This is due to the fact that eventually the economies of large scale production are
swamped by the diseconomies of large scale production and this results in decreasing
returns to scale.

11 | P a g e
ASSIST. PROF SACHIDANANDA SAHOO, IIIT, BBSR