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HAPTER

The Theory of Production:

Returns toa Variable Factor
Introduction problens. In this chapter
Sa far we have been discussing the demand side of the pricing
nextfewOnes We shall be discussing the
supply side of the pricing of products. The
andthe
we shall see in alater chapter, depends upon its cost of production,
sppyoffa product, as between inputs and output, and
ahich in turn depends upon (a) the physical relationship plays an important
output
the prices of inputs. The physical relationship between inputs and of this physical relation
the general description
nart in determining the cost of production. It issubject-matter of the theory of production. In
hetween inputs and output which forms the governing production of
other words, the theory of production relates to the physical laws
goods.
into outputs. The word
The act of production involves the transformation of inputs
physical transfomation in
production in economics is not merely confined toeffectingproduction in economics also
the matter, it is creation or addition of value. Therefore, Laws of production,
cOvers the rendering of services such as transpoting, financing, marketing.
and outputs developed
orin other words, the generalisations regarding relations between inputs production provides
of
in tris chapter willapply to all these types of production. The theoryhow to combine various
ojormal framework to help the managers of firms in deciding product or service.
Jactors or inputs most efficiently to produce the desired output of a
the 'Production
Ihe relation between inputs and output of a firm has been called
runction .Thus, the theory of production is the study of production functions. The production
varying
iction of a firm can be studied by holding the quantities of some factors fixed, while
e arnount of other factors. This is called short-run production function. The time period in
Mucn at least one factor or input is fixed and production is increased by varying other factors
aled the short run. Thestudu of short-run production function when at least one factor is
1. The Words inputs" and "factors" of production are most often used interchangably. But, to some
noisIS, meaning of inputs is broader. Inputs are all the things that tirms buy, while the factors of
production are taken tO mean suchthings as labour, capital, land, entrepreneur.
 244 of
diminishing
ehitof lou haxd, thetime period
returns whichie
when all
Manageria Eton
the
kery fred formstinne 0 the other
nn, thatis, the time factoredrs
are
periodrequi
for hits
al ints derends ontheindshuthe For some industriesSUCh as making of wooden
tohinhle Te lenoht of long of
un production
CAlv the long months but tor it steel, may
Tas talesnm srpal urs
fw o or thecapacity of steel production. The
Pxpex
ureks behai
m:he
tahxthe long proportionately is the subject-matter
of
mtatin uhen al
k Th8 tnthe
factors
then
sae ik
of
an varied
xution, the shudy
this,the
of (a)
theoryof
the returnsto a
productioniis also
ichded Besides factors of production) afirm
wil
variable relrs
maxichoosrmizee
fo
hthe ohrs ombinotion of inputs(or agiven level of output orto
eplaining whih paductionfor produing
ostt of
te minimiN it
PRODUCTIONFUNCTION
rodatiom, assaid above. istransformation of physical inputssinto physical outpts The
relationship between
nhka ottofhncthon
a firmisof known The functional
[Link] function. Algebraicallu. production physical inputs
i funcdisa
and
itpN thus a
Car written as d.......
=f(a, b, c,
q
wtere qstandsfor the quantityof output, a, b, c, detc.,standfor the quantities of fader
quantity (g) of output produced
respectivey. This functionshows that the [Link] above functon : tha
A.5.C D shows
qanttes, a, b, cdathefactors A, B, Cand
output qand the quantites finputs a, b,c,d
onthe ofi
there exsts some
relationship
form
between
ofthis relationship. This unspecifiedIrelationshipis i denoteetc. bt
does not tell usthe specific that is, if right hand
t form of the function f is
given, side of the
here by the ietter f. Hthe mathematical form, we can then fully find out we canthen
equaton ( is grven in a specific that the firm would produce with each set of impauts
the quantity of output
tand ou precisely
Sucth as abour and capital. rates af
production function is the name given to the relationship between the
The of product. It is the economist's summon
productive services and the rate of output
Input of production function expresses therelationstip
of iechnoiogical knouwledge." Thus, the
of various inputs used for the production.
between the quantity of output and the quantity maximium quantity of output that can be
More precsely. the production furnction states the per period of time or, in other words, i
produced from any given quantities of various inputs
required to yielda given quantity ot
Staies thé minimum quantities of various inputs that are remain constant. It is importantto
assumed to
output per period of time, the technology being
as introduction of a new automateu
ote that wten a change in technology occures, such get a new proaue
machirne or the substitution of sklled labour for unskilled labour we willfunction willconsStO
production
function hasmallfirm produces wooden tables in a day, its of various inputs
the maximum nurmber of tables that can be produced from iven quantities productionfunctiono
Such as wood. varnish, labour tirme, machine time, floor space. Or, the machine
labourtime,
that firm may also be defined as the minimum quantites of wood, varnish,
time, floor space, etc., that are required to produce a given number of tables per day:

thevales
qwhen
2 Afunction is said to be in a specitic form if we are able to find out the value of output
of the independent variables (a, b, c, d etc,)are given.
3. G.J. Stigler, The Theory of Price, 1953, p.106.
 245
Production:: Returns to a Varisble Factor
and is
Kinouledgeofthe production function is atechnological or engineeirng knowledge
be noted in
to
the firm byits engineers or production managers. Two thingsrust
ided
productionfunction. First, production function, like the dermand function, rnust be
t ofiwithreference to a particular period of time, Production function expresses a
onsere production
resulting in aflow of output in aspecific period of time. Secondly,
advancenent in
ofa irm is determined by the state of technology. When there is
thon
hn
the productionfnction changes with
the result that the new production can yield
the given inputs, or smaller quantities of inputs can be used tor
of output from
ting given
quantity of output.
rotu qa relations or production
heonomictheorv we are intersted in two types of input-output
study the production function when thequantities of some inputs are kept
tions Fist, we
hrn
andthe quantity of one input (or quantities of
few inputs) are varied. This kind of
onstant
relationforms the subject-matter of the law of variable proportion.
Since only in
PnNt Niut some factors are required to be held constant, the law of variable proportions
short run,
the short-run production function. Secondly, we study the input-output relation by
in the
oatesto
proportionally. This forms the subject-matter of returns to scale. Since
allinputs long-run production
Kong-rnal factorsscan be varied, the question of returns to scale relates to
fnction.
forms; it can be represented by
Droduction function can be represented in verious
biosaraphs, mathematical equations, showing the maximum quantity of output that a firm
period of time with various combinations of factors (i.e., inputs). When two
an produce per function can be represented by isoquants (i.e.,
ators have to be explicity shown, production also be represented by input-output tables.
eual product curves). Production tunction can
production function provides quite a useful
However, it isworth mentaining that although a firm, it does not given all the information
ntormation about the production possibilities open to
produce a given level of output or to determine
reuired for efficient combination of inputs to
mentioned above, production function, while a
the profit maximising rate of output. As
process, describes a physical relationship
indarmental part of managerial decision-making output to determine the efficient resource
which must be combined with prices of inputs and find out the profit-maximising rate
combination of producing a specific level of output and to
of output to produce.
FACTOR
PRODUCTION FUNCTIONWITH ONEVARIABLE
interested in two types of input-output
As mentioned above, in economic theory we are
production function when the quantities
relations or production functions. First, we study the
of one input (or quantities of few inputs) are
Ot sOme inputs are kept constant and the quantity subject-matter of the law of diminishing
varied. This kind of input-output relations forms the proportions and describes returns toa
narginal returns which is also called law of variable
relation by varying all inputs, that is, production
Jactor. Secondly, we study the input-output factors.
unction with two or more than two variable The latter forms the subject-matter of the
production function with one
Ietuns to scale. In the present chapter we shall explain the to scale. It may be noted that
Variable factor and in the next chapter we shall analysis returns run because in the short run
cOncept of returns to a variable factor is relevent for the short
fixed and factors such as
Ome tactors such as capital equipment, machines, land remain factor prooduction
OOUr, raw materials are increased to expand output. Thus the short-run two
Tunction can be written as
Q=fL, K)
constant in the
Where Q stands for output, L for labour and K for capital which is held
 246
An
short nm (Note that har on Kindicates that itis held constant). which is
rohction tunction knoun as Cobb
economics is Titten as
Douqlas production function
importanTnostt speritic
Where i is the amount of labour, Kis the amount of capital used in
rocess and A , ß are constants ither Kor L can be held constant and he
other fato can he ainceascd to studythe returns to a factor. The
tactor is concerned with the study of how output (Q) changes when the Concept arnNrt eh
of ro
tactor such as labor is increased. In what follows we will first explain
proct that are generally used for the study of returns to a
arm ount
of a
Sorne
phusical variable COre
Tetal, Ave rage and Marginal PhysicalProducts factor.
Regarding physical production of factors there are three concepts : (1)
Awerage hatuct, and (3) Marginal Product. Tostudythese concepts of a Total
to the use of a varnable factor, saylabour, we assume that afirn leases a
horse power and employs it in the production process as a fixed factor. prmachioductnievityvith 10
amount of a labour (ie., the number of workers) employed to operate
the
vanous quantities of output of the product will be produced. In Table 12.1 we
of output that is. producedbyemploying more workers with the given
DegivepgienvthendiergTrochino,
machine
capital) Thus the data of Table 12.1 represents the production function
input (labour). hoiding capital constant. We shall with (ione.e.,tqhuvariaert letau,tg
Tible 12.1 Total Product, Marginal Product, Average Product of Labour
Labour (i.e. No. Total Product Marginal Product Average Product
of workers) (TP) (MP) (AP)
Output Elastich,
of Labour
AQ Q
AL L E)
1 80 80 80 1
2 170 90 85 1.06
3 270 100 90 1.11
4 368 98 92 1.06
5 430 62 86 0.72
6 480 50 80 0.62
7 504 24 72 0.33
504 63 0
9 495 -9 55 -0.16
10 480 -15 -0.31
48

now explain the concepts of total product, marginal product and average product of la0ou
with the help of Table 12.1 and the curves.
Total Product (TP). The total product of a variable factor is the amount of total ou
produced by a given quantity of the variable factor, keeping the quantity of other factors
as capital, fixed. As the amount of the variable increases, the total output [Link]
rate of increase in total output varies at different levels of employment of the variable factor
will be seen from Table 12.1 that as more workers are employed with a given quantiy
capital (i.e. , the given machine), the total output of the product (TP) increases. When o
employmento
worker is employed with a machine, total output is 80 units of
output, with
2 workers with the machine, the total output increase to 170 units, with employmentofthre
 ofProduction:
heTheory Returns toaVarlable Factor 247
workers,thetotal output incresases to 270. It will be seen frorn Table 12.1that when more
than3 workers are employed, total output (TP) starts increasing at a dirninishing rate and
whenmorethan 8 workers are emploved, total output (TP) starts decreasing.
The behaviour of total product is graphicalyshown by the total product curve TPin
Fiqure121 where it will be seen that inthe beginningtotal product curve rises at an increasring
[Link] is,the slope of TP curveis rising inthe beginning. After a point total product curve
starts increasing at a diminishing rate as the employment of the variable factor labour is
increased The fact that ultimately total product increases at a dirninishing rate has been
provedtobe valid on the basis of empirical evidence, as will be seen later in our discussion of
thelau of diminishing returns.

(@) TP

Product

Physical

Total

Lt Lg X
Labour (L)
Fig. 12.1. Total Product Curve of Labour.
Itmay be emphasized again that the total product curve shows how the total output of the
firm changes by increasing the quantities of a variable factor, say, labour assuming that the
fixed factor (capital) is held constant. The total product curve of labour starts from the origin O
because it is reasonable to assume that the fixed factor capital alone cannot produce any
output. When the firm uses OL amount of labour alongwith a fixed amount of capital, the
total product equals L, Q,units of total output. As employment of labour is increased to OLy
the total product rises to L, Q,. Likewise, total product of the variable factor along with afixed
amount of capital continues to increase until OL,units of labour are employed at which the
total production of labour with a given amount of capital reaches the maximum level LQa:
Further increases in employment of labour cause total product to decline. We shall discuss in
detail later why total product of the variable labour decreases beyond a point.
Shift in the TotalProduct Curve. The total product curve of a variable factor (labour)
is drawn on the assumption that the amount of a fixed factor capital is heldconstant. Now, any
change in the magnitrude of the fixed factor capital will cause a shift in the total physical
product curve of labour, the variable factor.
In Figure 12.2 the total productcurve TP, of labour is drawn assuming that capital is held
Constant at agiven amount K, of capital. (Note that for the sake of simplicity we have drawn
n hig. 12.2 the total product curves with decreasing slope only.) Now, if the amount of capital
 variablela
ofthe increasein
248 prouctcurve K). Aturther
total cuwTP.(K-
increases to Ko. the 2 wthe
a
K, will cause capital to the
further
12 the total product curve
Momin Pgure
(K- Ka).It is thus
evident that
product Curve of the
0-.K,) TP labour, depends uponvariatblo
(O) TP
ofthe fixed
quantity
to work with. The fgreatactoerr howcapital
Product
quantity of the capital, thehe aral
prodiier o
TP be the level of the total
Ptysical TP of labOur.

Total
o-L K) Average
Product
Average product of a
(labour) is the total output variable
bythe amount ofIlabour
a given quantity of capital
factor) used to produce a
ernpkoyet w
Labour

Total Product Curve Due

to
Thus corirnodit,
Fig.12.2. Shit in
K, <Kg).
norease in the Fixed Capital (K < AP.
Q
L
where AP, representsthe average physical product of labour, Qrepresents the total outot
quantity of labour employed, Lstands for the quantity of laboy
employed.
produced byForusing
example given
a in Table 12.1 whenthe total output produced is 170 units by employirg
workers (along with a fixed quantity of capital), the average product of labOur willb
2
170 = 85
AP
given capital. 271
Similariy, in Table 12.1when three workers are employed with the
units of output are produced, average product of labour,
270 =90
AP = 3
It will be seen from Table 12.1 that average product of labour (AP) isincreasing untl!
workers are employed and beyoud that average product (AP) of labour starts declining.
Derivation of Average Product Curve From the Total Product (TP) Curve. I
average physical product curve can be easily derived from thetotal product curve of
labour. This is illustrated in Fig. 12.3 where when OL, amount of labour is used, the toa

iseq1al
output is L,Q,. Thus, the average product of labour is equal to OL1 But OL,
the slope of the line connecting Q, with the point of origin (that is, tangent of angle ,
Similarly,average product of labour when OL, quantity of it used can be obtained by coneu
L
the point Qwith aline to the origin and finding out its slope which will be equal to OL,
thetote
Fig. 12.3, it will be seen that the average product curve of labour, as derived from increae
product curve TP, is changing with the increase in the variable factor, labour. As we
 s i
function
production
with uput emediargnal lableHeres testhe metres twwOr
gimarginal
ven o ofkers oal the ommodity
spen to the
up
roductsamount
,
Infinitesimal
changes n 12.1 workers,
of productionMarginal average has h Q
by
general, to to cloth, are from OL; .Q,.g
AQ zeroproduct machine
tota l been and
units,
employment
and marginal
that
output. physical then three
if of (capital),
on a Thus,
enployed
the
Product
the
by productFiguregenerally
with quantity
fixed
a
then.
have
labour
of
l Total physical product (a) fProduction:
the worker product third workers
employment to 12.3, of gChanging 12.3.
Fig. Returns
respect to marginal employing
product produce curve quantityoflabour a Q4 from
in the worker (MP). the tound decreasing Thus, etc. product
curve
physical
Total
diminishesmarginal total of are of used
and L, to
theMarginal average
labour, onto Q a
labour of (MP) the a that Variable
product
MP = abour more employed
product thrid has product of factor another, the Lg,
the product added an as slope. total
and is than andlabourof worker. extra would
product thereafter more it we
Physical
Average Factor
marginal ALAQ of product lines
find
that
increases 8 increases 100 and and average product
written
labour" workers when of unit have of units Labour
rises Similarly,metres asthey
workers
product & a of of labour decreases. average
as is MPof workersinitially
by to result produce a a an product of curve
dL given has 368, to factor. variableinverted a L7
AL when the total first factor physical labour origin
withetpoints
h Product
Labour. of
labour of
is connecting
is unitslabour are declined
but that total SuppOse 170 rises first
by
employed, after is, four product units factor U-shape. rises
are
ALyielding
AQ has production. and
employed product
fourth
workers
to is
desivative
firstthe 3 98. of in the then and
Thatis, become workers increases output. Table increasing have TP
increases factor
It addition then
it of
MP are
negative. ofare employed
wil Thus
Now, 12.1 diminishes itfor total
of
behas to made producting
falls.
labour seenadded
employed 100 270 when
in if increases physical
metres instead As
the of to slope
total has from 98 with units two the That
wil a
249
 can
variablefactor of labour
250
The marqinal
c
product e
anv
of a
given level of
employment
otal
margithenal
productcurve a
labor
predct cnr of
latvr Almeasuring
obtainedhu
thesope of
figure 124 when
the
OL, units of
tangent drawn at
are erjv
ner
plno leay
marginalpoint
ho can he in A
emploument For evampo the slope of the
Iaho phusical oflabvuris otenbu oflabour areemployed, prodct product
marginal when units
OL., drawntothetotal CUrve Tp
7P Agin, sloeof thetangent
product ne meaerinothe employment.
KohBaned h to O leel oflabour G
homesponding

Totalphyslcal TP
productcurve
E
(a) hlectionpoint
product

physical

Total

L L2 Lg La Labour
Physical Product Cunve
Fig. 12.4. Deriving Mariginal
at different levels of employment oi k
The marginal product of a factor will change rises in the beginning and them
fador. t has been found that marginal product of a factor remaining the some. Thatis
utimateiy fals as more of it is used for production, other things
rising in the beginning unt
why in Fig. 12.4 marginal product (MP) has been shown to be starts diminishing, Poin
point D, that is, when OL, workers are employed and beyond that it diminishing beyond the
Dis known as point of inflection. Marginal product of labour goes on
infiection point Duntil it becomes negative beyond point G.
The relationship with average product and marginal product curves and how both a
them are related to the total product curve has been graphically in Figure 12.5.
Output Flaticity of an Input
An impotant concept relating toproduction function with one variable input is oup
elasticity of an input. Just as price elasticity of demand for a good is defined as perceni
change in quantity demanded of it that results from a given percentage change in pricethati
output elasticity of avariable input, say labour, is the percentage change in output othe
brought about by agiven percentage change in the quantity of variable input used,
factors such as capital remaining the same. That is,
%AQ
E = % AL
 The Theory of Production: Returns to aVarlable Factor 255

MPK =OK =0.25x 1.50 10.75K-0.75

0.375 L0.75 K-0.75

APk Q 1.5010.75 K0.25

K K
= 1.50 [0.75 K-0.75
0.375 [0.75 K-0.75
E7 = MPK
APk 1.50 0.75 K0.75
= 0,25
From the value of output elasticity of labour equal to 0.75 it follows that 1 per cent
increase in employment of labour causes 0.75 increase in output, that is, less than
proportionately. SimilarBy. output elasticity of capital being equal to 0.25 implies that one
per cent increase in capitalcauses 0.25 per cent increase in output of the commodity.
LA OF DIMINISHING RETURNS
Law of diminishing returns occupies an important place in economic theory. This law
examines the production function with one factor variable, keeping the quantites of other
factors fixed. In other words, it refers to the input-output relation when output is increased by
varying the quantity of one input. When the quantity of one factor is increased keeping the
quantity of the other factors constant, the proportion between the variable factor and the fixed
factor is altered; the ratio of employment of the variable factor to that of the fixed goes on
increaseingas the quantityof the variable factor is increased also. Since under this law we
study the effects on output of variations in factor proportions, this is also known as the law
of variable proportions. The law has played a vital role in the history of economic thought and
occupies an equally important place in modern economic theory and has been supported by
theempirical evidence about the real world. The law of diminishingreturns has been stated by
various economists in the following manner :G. J. Stigler, a Nobel prizer winner in economics
writes, "As equal increments. of one input are added ; the inputs of other productive
services being held constant, beyond acertain point the resulting increments of product
will decrease, i.e., the marginal products will diminish.4
Similarly, Samuelson,another Nobel Laureate, writes that when"An increase in some
inputs relative to other fixed inputs will, in a given state of technology, causes output to
increase; but after a point the extra output resulting from the same additions of extra
inputs will become less and less.5

Assumptionsof the Lawof Diminishing Returns. The law of diminishing returns

as stated above holds good under the following conditions:
1. First, the state of technology is assumed to be given and unchanged. If there is
mprovemernt in technology, then marginal and average product may rise instead of diminishing.
2. Secondly, there must be some other inputs such as capital must be kept fixed. It is only
nthis way then that we are able to measure the changes in output caused by increase in a
*GJ. Stigler, Theory of Price,The Macmillan Co., 1953,p.111.
0. [Link], Economics, 8th edition, p.25.
 its effori
256 proportionsand know on
alterthefactorproportionately varied. Behaviour
variabBe tactorthat
lew does not
we can
apph n case all
factors are under "returnsto scale"
5 Thindly, the lawis based
result of the variations in all
discussed
inputs is the possibility ofvaryingthe proportions in which
upon
of
outpT
combinedto produce a product. Thelawdoes
yield a
notapply
product. to
Vanous factors can b proportions to
must be sed in fixed fixed proportions,then the When the
Where the factors
requiredto be usedin
rigidly product ofincrease
tho in
Thctors
cero ar output, that is,the marginal
and not diminishing. It may however be pointed out that products requiring fvay
wnuld not lead toanvincreasein
diminishing
factor wiltherbe
guite uncommon. Thus thelaw of marginal
the cases of production,.
proportions of factors are to most of
proportions applies
known as law of variable the quantity of a
Retrns to a variable factor,
say labour, keeping fixed factor
shall first explain it
12.1 and Figure12.5. Weland with which by
onstant is illustrated
lable 12.1 Assume that
labour. is usedto
in Table
there isa
produce wheat.
given
With
fixed
a
amount of more
given fixed quantity of land, as atarmer
variable consderita
unit to 7 units, total product increases from 80
employment
504 quintals
of
of
labour
wheat.
from
Beyond
one
the employment of 8 units of labou, total product
3 units of labour, total product increases at an
useaofdiminishing
quidirninntiaslisets
up tothe at
Ris worth
rate notingthatit increases
and afterwards rate. This fact is clearly revealed from colutn
3which showsSsuccessive marginal products of labour as extraunits of labour are used. Margina increasina
product of labour, it may be recalled, is the increment in total output due to the use of an extra
unit of labour.
t will be seen from col. 3of Table 12.1 that the marginal product of labour initially rses
and beyond the use of three units of labour, it starts diminishing. Thus when three units o
4th and Sth
labour are employed, marginal product of labour is 100 and with the use of
of labour marginal product falls to 98 and 62 respectively. Beyond the use of eight units
iabour, total product diminishes and therefore marginal product of labour becomes necatie
Asregards average product of labour, it rises up to the use of fourth unit of labour and bend
that it is falling throughout.
Three Stages of Production.
The behaviour of output when the varying quantity of one factor is combined with afised
quantity of the other can be divided into three distinct stages. In order to understand thes
three stages it is better to graphically illustrate the production function with one factor variabe.
This is done in Fig. 12.5. In this figure, on the X-axis we measure the quantity of the varnatde
factor and on the Y-axis we measure the total product, average product and the margjind
product. How the total product, average product and marginal product of the variable tacu
change as a result of the increase in the quantity of one factor to afixed quantity of the othas
will seen from Fig. 12.5. The total product curve TP goes on increasing to a
be
point al
that it starts declining. Average and marginal product curves also rise in the beginnng a
then decline, marginal product curve starts declining earlier than the average
The behaviour of these total, average and marginal products of the variable produci u
to the increase in its amount is generally divided into three stages which are factor consebelow:
explained
Stage 1: In this stage, total product increases at an increasing rate to a point.
12.5 from the origin tothe point F, slope of the total product curve TP is increasing. thatis,up
tothe point F, the total product increases at an increasing rate (the total product Curne
IP
is concave upwardssttothe point F), which means that the marginal product. MPrises. Fromthe
point F onwards during the stage 1, the total product goes on rising but its slopeis decining
TheiTheoryof Production: Returns to a Variable Factor 257
Aichmeans that from point Fto the point H the total product increases at a diminishing
rate(total prroduct cuve is concave dowmwards),, i.e., marginal product falls but is positive. The
point F where the total product
stops increasing at an increasing H
ato and starts increasing at the
iminishing rate is called the point
of inflecion. Corresponding Output
Total TP
vertically to this point of inflecion
marginal product is maximum,
after which it starts diminishing. Point of
Inflection
The stage lends where the
average protict curve reaches its
highest potnt. During the stage 1, Stage 2 Stage 3
when marginal product of the Stage 1
Uariable factor is falling, it still
exceeds its average product and
So continues to cause the average
Amount dfa Variable Factor X
Droduct cuve to rise. Thus,during
the stage 1, whereas marginal Product
product curve rises in a part and
then falls. the average product Marginal
Curve rises throughout. In the first
stage, the quantity of the fixed
factor is are too much relative to and D
the quantity of the variable factor Production
so that if sorne quantity of the
fixed factor is withdrawn, the total
product would increase. Thus, in Average
the first stage marginal product AP
of the fixed factor is negative.
Stage 1 is called by some Stage 1 Stage 2 Stage 3
economits as the stage of o
increasing returns because M X
average product of the variable Amount of a Variable Factor
MP
factor increases throughout this
stage. It is notable that the Fig. 12.5. Three Stages of Production Function with
marginal product in this stage one Variable Factor.
initialy increases and in a later
part it starts declining but remains greater than the average product throughout in stage lso
that the average product continues to rise.
Stage 2: In stage 2, the total product continues to increase at adiminishing rate until it
reaches its maximum point Hwhere the second stage ends. In this stage both the marginal
product and average product of the variable factor are diminishing but are positive. At the end
of the second stage, that is, at point M marginal product of the variable factor is zero
(Corresponding to the highest point H of the total product curve TP). Stage 2 is very crucial
and important because the firm wilseekto produce in its range.
258 Siage 3: In stage 3total product declines and therefore the total product cUne T
slopes downward. As a result, marginal product of the variable factor is negatVe and .
Managa i tontn
the X-axis. Inthis stage, variable factor
is
MP oops below the stage of negative returns,
marginal product
the
c
fixed
e
factor Thisstage is called
duringthis stage.
since
the Marog
Telathve to negative
product of the variable factor is are completely symmetrical In
margisntalage
stage 3
R mav be notedthat stage 1andvariable factor. Theretore,in stage 1,
of the fixed factor is negative.
relativeOnto
the
theother hand, in stage 3 variablefactor istoo much relaty
TINedfactor istoo much product of the
fixed factors. Therefore, in stage 3, the marginal variable
to the
negative.
Now an of
The Stage Operation
important question is in which stage a rational producer will seek to prOdute.A

never choOse to produce in stage 3 where marginal product

variable factor
rational will Marginal product of the variable factor being negativein stage3,
is negative.
producer
producer can always increase his output by reducing the amount of variable factor. It is hs
Even if the
be producingin stage 3.
producer will stop at the end of stage 2 where the marginalvariable
never
free,
clear the rational
thatrational
a producer will product of te
variable factor is zero. At the end point Mof the second stage where the marginal produt d tactor's
the variable factor is zero, the producer will be maximizing the total product and will thus te
making maximum use of the variable factor.
Arational Iproducer will also not choose to producein stage 1 where the marginal produt
of the fixed factor is negative. Aproducer producingin stage l means that he wil not be
making the best use of the fixed factor and further that he will not be utilizing hully the
variable factor wh
opportunities of increasing production by increasing quantity of the entrepreneur wil
average product continues to rise throughout the stage 1. Thus a rational
stop in stage 1 but willexpand further. Even if the fixed factor is free (i.e., costs nothingl tha
rational entrepreneur will stop only at the end of stage 1 (i.e., at point N) where the average
product of the variable factor is maximum. At this end point N of stage 1 he will be makina
maximum use of fixed factor.
t is thus clear from above that the rational producer willnever be found producing i
stage l and stage 3. Stage l and stage 3may, therefore, be called stages of economic absud
or economic nonsense. Thus stages 1and 3 represent non-economic region in productian
function. Arational producer will always seek to produce in stage 2 where both the margha
product and average product of the variable factor are diminishing. At which particular poit
in this stage,the producer will decide to produce depends upon the price of the variable tactot
The stage 2 represents the range of rational production decisions.
We have thus seen how the output varies as the factor proportions are altered at ay
given moment. We have also noticed that this input-output relation can be divided into thre
stages. Now the question arises as to what causes increasing marginal returns toavarabk
factor labour in thebeginning in stage 1, diminishing marginal returns to the variable la
which start operating from point Din stage l and continues in stage 2and utimately we ha
negative marginal returns in stage 3. We explain below the factors which cause the increasty
6 The statement in respect of the non-operation by arational producer in stage 1 appliesto the produce
who is working under perfect competition in both the product and factor markets wherethe prue0
product sold by him and the prices of factors bought by him remain fixed. In monopoiy andimpered
competition in product and factor markets where the prices of product and factors do notremain
with the changes in thelevel of output and employment, the producer might find hisS most profitable eve
of output in stage 1.
 Production: Returns to a Variable Factor 259
Theoryof
he
diminishingand genative marginal returns to the variable factor.
CSesofInitial Increasing Marginal Returns to a VariabBe Factor
beginning. the quantity of the fixed factor is abundant
hthe relative to the quantityof the
factor Therefore, when more and rmore units of the variable factor are added to the
tariable quantity of the fixed
factor, then the fixed factor is rnore intensively and effectively
onstantthat is,the efficiency of the fixed factor increases as additional units of the variable
utihzed
added to it. This causes the production to
factorsare increase at a rapid rate. When, in the
[Link] variable factor is relatively smaller in quantity, Sorne amount of the fixed factor
remainunutilizedland, therefore, when the variable factor is increased fuller utilisation of
maU becomes possible with the result that increasing
fixedfactor returns to a variable factor are
[Link] questionn arises as to whythe fixed factor is not initially taken in a quarntity which
the
available quantity of the variable factor. Answer to this question is
suitsthe taken
providedIby the fact
generally those factors are as fixed which are
indivisible.'
thatIndivisibilityof afactor means that due to technological requirements a minimurm amount

must beemployed whateverthe level of output. Thus, as more units ofthe variable factor
employedto work with an indivisible fixed factor, output greatly increases due to fuler and
ofit
are effective utilization of the latter. Thus we see that it is the indivisibility of some factors
more
whichinitially
causes increasing returns to a variable factor.
The socond reason why we get increasing returns at the initial stage is that as more units
ofthevariable factor are employed the efficiency of the variable factor itself increases. This is
because when thereis asufficient quantity of the variablefacto, it becomes possible to introduce
specializationor division oflabour which results in higher productivity. The greater the quantity
Jhe variable input, the greater the scope for specialization and hence greater will be the level
of productivity and
efficiency.
Causes of DiminishingMarginal Returns
The stage of diminishing returns in the production function with one factor variable is the
most inportant. The question arises as to why we get diminishing marginal returns after a
certain amount of the variable factor has been added to the fixed quantity of the other factor.
concerned with
tisimportant to note that the famous law of diminishing returns in fact
diminishing marginal returns and not diminishing total returns i.e. total product of a factor.
Scarcity of the fixed factor. Asexplained above, increasing returns to a factor occur
the fixed factor as
in the first stage primarily because of the more effective and efficient use of reached at
more units of the variable factor are combined to work with it. Once the point is the
utilization of
which the amount of the variable factor is sufficient to ensure the efficient
bxed factor, further increases in the variable factor willcause marginal and average products
to the quantityof
lo decline because the fixed factor then becomes inadequate relativemade
Ihe variable factor. In other words. the contributions to the production by the variable
additional units of the variable
aor ajter a point becomes less and less because the is the result of
uCor haue less and less of the fixed factors to work with. Theproductionstage 1, the fixed
in
the
co-operation of various factors aiding each other. In the beginning
relative of thewithvariable
numberwhen
to the hand, factor and the former provides much
theabundant
aid to S latter. On the other theincrease in the variable factor the fixed
so that as the units of
factor becomes more and more scarce in relation to the variable factorfixed
receive less and less aid fromthe factor. As aresult,
evariable factor are increased they
the marginal and average products of the variable factor decline.
1. Moreover, a factor has to be taken in afixed quantity because this is one way in which we can alter the

proportion and judge its effect on output.

 diminishin.
phenomenonof
260
the
of FixedFactor The
rests
Indivisibilitv marginal returns,
like that of increasingimotant reason for
upon the
indivisibility of th
increasing
l ic
returns In stage
whetherthe outputto be
Tthemargirnfactal
reth
paned aboe. the employed
ubich hastobe tactor is not beingfully USed. produc
effiSUCCecients ive
indiisihe
Nedfactor is
wben the indvisible fixed since tuller and
more
Olarge hn stage l more to output ofthe
facto add more
and
a limittothe range

ermployre t
vaiable qenerally
tne Butthere is product willincrease. There will
of the indhisible fixedfactor
orr whichit average indivisiblefixed factor is being as Usual
fully
ly
be al
tne \anable factor which will and
emploument of
VanabBetactor hasand
as possible
(seo'best
thevaiablefactor at marginal product is maximum. It
inceased to such
thenefore happen dfi ert
the an amountthat the fixed indivisible factor is being iset
the or optimum proportion' withthe variable factor. Once the optimurm proportin

variablefactor, marginal returns tothe variable

diminish
inthe
isturbed bufurther increases primarily becausetheindivisible factor
margina product) will factor. Just as the marginal product of the variable
proportion withthe vaiable of the fixed indivisible
being
factor is
used in
factor
being
tacore
better and fuller use
n the beginning when variable factor diminishes when the fixed indivisible made.
margina product of the
factor
worked too hard.
factor was finely divisible, neither the increasing nor the diminishingImargina
returnsFthe fixedhave occured. If the factors were perfectlydivisible then there would not have
woukd
been the necesity of taking alarge quantity of the fixed factor in the beginning to combine
with the varying quantities of the other factor. In the presence of perfect divisibility of the
factors, the optimum proportion between the factors could have been achieved in eveny
case. Perfect divisibility of the factors implies that asmallfarm with a miniature combine and
one worker would be as efficient as a large farm with a large combine and many workere
productivity would be the same in the two cases.
Thus we see that if the factors were perfectly divisible the question of varying adtgy
proportions would not have arisen and hence the phenomena of increasing and diminishinn
marginal returns to afactor would not have occurred. It has been rightly said, "Let divsibaity
enter through the door, law of variable proportions rushes out through the window."
Imperfect Substitutability of the Factors. Joan Robinson goes deeper into the causES
of diminishing returns. She holds that the diminishing returns occur because the factors of
production are imperfect substitutes for one another. As seen above, diminishing margiad
returrns occur after apoint since the fixed factor becomes inadequate relatively to the variabk
factor. Now, afactor which is Scarce in supply is taken as fixed. When there is a Scarce tacto,
quantity of that factor cannot be increased in accordance with the vaying quantities of te
other factors which beyond the optimum proportion of factors will result in diminishing margna
returns. If now sorme variable factor was perfect substitute of the scarce fixed factor, then te
paucity of thescarce fixed factor after a stage would have been made up by increasing t
supply of this perfect substitute with the result that output could be expanded without diminsily
marginal returns. Thus, even the variable factor which we add to the
perfect substitute of the fixed factor, then when the fixed factor becomes fixed tactor wa
relativelyfactor
its deficiency would have been made up on account of the increase in the variable detiCe
which
is its perfect substitute.
Thus Joan Robinson says, "What the Law of Diminishing Returns really states isthat
there is imit tothe extent to which one factor of production can be substituted for another.o.
in other words, that the elasticity of substitution between factors is not infinite. If thist werenot
true, it would be possible when one factor of production is fixed in amount andthe rest areiî
 261
TheoryoffProduction: Returns to a Variable Factor
the fixedfactor, andthen,
The
produce part of the. outpit with the aid of
pertecthelastic supplv, to
optimum proportion between this and other factors Was attained, to substitute sorne
hon the diminishing
forit and toincrease output at constant cost." We therefore see that
Dthertacfor between factors is not
marginalreturns operate because the elasticity of substitution
infinite.
Ceuses of Negativre Marginal Returns
quantity of
As the amount of the variable factor continues to be increased to the constant
marginal product becomes
cho other. a stage is reached when the total product declines and thevariable factor is due to the
sative. This phenomenonof negative marginal returns to the factor so
iat that the amount of thevariable factor becomes too excessive relative to the fixed
hat they get in each other 's way with the result that the total output falls instead of rising.
Resides. too large anumber of the variable factor also impairs the efficiency of the fixed factor.
The proverb "too many cooks spoil the broth" aptly applies to this situation. In such a situation,
areuction in the units of the variable factor will increase the total output. Just as in the first
stae. marginal product ot the fixed factor was negative due to its abundance, in the third
ae the marginal product of the variable factor is negative due to its excessiveness.
GENERAL APPLICABILITY OFTHELAW OF
DIMINISHING RETURNS
We have discussed above, the law of diminishing returns which states marginal physical
Droduct eventually diminishes, even if it is increasing in the beginning. Uptill Marshall, it was
thought that three laws of production-diminishing, constant and increasing returns were quite
distinct and separate. Now, modern economists have veered round to the view that diminishing,
constant and increasing returns are not three separate laws but they are three phases of one
general law of variable proportions. Moreover, uptill Marshall it was thought that law of
diminishing returns applied to agriculture and the m¡nufacturing industries were characterised
by increasing or constant returns. But this is no longer believed; law of diminishing returns has
vast general [Link] law applies as much to industries as to agriculture. Whenever
some factors are fixed and the amount of other increases, then the technology remaining the
sarme, diminishing returns to a factor are bound to occur eventually both in agriculture and
industries. We have given above thevarious definitions of law of diminishing returns which lay
stress on its general applicability.
Itis important tonote that lawof diminishingreturns is
the law of economics derived through deductive logic. As forempirical generalisation and not
its validity is concerned, we have
given the various reasons for the occurrence of
diminishing returns.
diminishing marginal physical returns to a factor after apoint has beenThe occurrence of
Overwheimingempirical evidence. Indeed, if thediminishing returns did notconfirmed occur we
by the
grow sufficient amount of foodgrains even in a flower pot by could
capital. If the constant returns could be obtained by using more dozens of labour and
land, then as the population increased we could use applying more labour on a given piece of
ncrease in agricultural output. In that case world, more labour on that land to get proportionate
Wouldnot have to face problems of food shortage and especially developing countries like India,
night when he says, "Indeed, were the
hypothesis of
overpopulation. Prof. R. G. Lipsey is
need to be no fear that the present diminishing returns incorrect, there would
population
narginalproduct of additional workers applied toexplosion will bring with it a food
a fixed quantity of land were crisis. the
If
constant, then
O. Joan Robinson, The
Economics of Imperfect Competition, p. 330.
 262
proportion to the increase in
Od fod prohtn udhe exanded in
bu keeping the
an inexorable decine
proportion
in
of the population on farms. As it is
same the marginal proctct of each adtitional labourer
technkques, to a fixed world supply ofAiminishpinogpularteitounerXnpsar
as an
population is appied, with static
Ihs, it shoukd not euderstood that because of
hopes for raising the higstadants of mankird, especialy
diminishing returns
ofthe people in agricultthuerrael canland
Owing to the gloomv pgnosis about the future of mankind made bythe
specialy Thomas Malthus. on the asis of diminishing returns, the subject of
devel o pi r
das ical ecaocnaerateri
Came to be called as a disnal science Howeer, to predict such a gloomy
Tuure of mankind on the asis of law of diminishing returns is wholly
people hae misderstodthe law and have asserted that as the population
qUantity of land remaining unchanged, the productivity per person will decline will
prospects
unwarraintncreedase
provision But this te
wrong Law of diminishing returns, as stated above. has a greatcountries thhat
day developed
equipment. ett remain the same. In the present
nas increased, agricultural productivity has greatBy gone up instead of though tepoplchndha
because present day developed countries have made an impressive progress in This
knowiedge, resulting in new and superior machinery and other equipment. and diminishing
tertilizers. Capital equipment per worker engagedin agricuture has greatly
resukt. agricuBtural prodictivity has registered a phenomenal increase in the
the tec
[Link] As
i
Countries.
On the other hand, developing countries have not made much
present-day
knowiedge and in capital accumulation and therefore do not use sufficient progress in techri
capital and.
ike machinery, toos. fertilizers, etc. It is no wonder, therefore,that agricultural
them has not risen significanty. In fact, marginal productivity of labour has
phenomenon of disguised unemployment foundin agricuture of developing COuntries gone down. The
that marginal productivity of a worker is zero or nearty zero. It is thus clear thattactual reves
produecqtuiivpinmey t
regarding the behaviour of agricultural productivity in both developed and developing c
is in no way a contradiction to the law of diminishing returns, the operation of which is
to the condition that technical knowledge, capital
expenence
remain the same. Even in developing countries such asequipment and other aids of prod
Indiawhere new agricultural technoe
represented by the use of HYV seeds,fertilizers, irigation has been adopted, the producti
of labour and land has greatly increased which is described as green revolution. For Ia
ataining food self-sufficiency, credit goes to the adoption of this new agricural technoloqy.
Of course, if we fail to improve our technology
sufficiently and to bring about raoid
capital accumulation diminishing returns would assert themselves
food crisis and starvation. We therefore conclude "unless thereand create the problems oi
is continual and rapidly
accelerating improvement in the techniques of production, the population explosion mus
bring with it declining living standards ouer much of the world and the
famine. "10 eventual widespret
OPTIMAL EMPLOYMENT OFTHE VARIABLE FACTOR (INPUT)
Howmuch variable input (labour in our analysis) willbe used by a firm
? Ths guiding principle is the same that to maximise protts
underlies
maximise profits will use or employ the extra unit of amarginal analysis. A firm that ams
the additional revenue generated by it exceeds the variable input such as labour as longe
marginal product of an extra unit of labour is 5 units ofmarginal cost of hiring it. Supp0e u
output and price of each unit ot oui

9. Richard, G. Lipsey, Introduction to Positive

10. Tbid. Economics, 3rd edition p. 216.