Chapter – 7
Production Function and Returns to a Factor
Production Function
Production function is the functional relationship between physical inputs and physical
output of a commodity.
𝑸𝑿 = 𝒇(𝑳, 𝑲)
FACTORS OF
PRODUCTION
FIXED VARIABLE
FACTORS FACTORS
Fixed Factors: Fixed factors are those the application of which does not change with the
change in volume of output. For example: Machinery.
Variable Factors: Variable factors are those the application of which changes with the
change in volume of output. For example: Labour.
Short Run Production
Function Short run is a period of time when production can be increased only by increasing
the application of variable factors (labour), fixed factors remains constant.
𝑸𝑿 = 𝒇(𝑳, 𝑲)
Since K is constant and only L changes, the ratio (or proportion) between L and K tends to
change. So, short run production function is called ‘variable proportions type production
function’.
Long Run Production Function
Long run is a period of time when there is no difference between ‘fixed factor’ and ‘variable
factor’. All factors are variable factors.
𝑸𝑿 = 𝒇(𝑳, 𝑲)
Here, both L and K are variable factors. Output is increased by increasing the application of
both the factors.
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In the long run production function, factor ratio remains constant. So, it is called ‘constant
proportions type production function’.
Basis Short Run Production Long Run Production
Function Function
1. Type of Production It is a production function in It is a production function in
Function which factor ratio tends to which factor ratio does not
change with change in change with change in
volume of output. It is called volume of output. It is called
variable proportions type constant proportions type
production function. production function.
2. Manner of Increasing Output is increased by Output is increased by
Output increasing the application of increasing the application of
one variable factor only. all the factors.
3. Scale of Output Scale of output remains Scale of output tends to
constant. : Constant scale of change. : Variable scale of
output. output
4. Type of Returns It is studied with reference to It is studied with reference to
‘Returns to a Factor’. ‘Returns to Scale’.
Total Product (TP): It is the sum total of output produced by all the units of a variable factor
along with some constant amount of the fixed factors use in the process of production. It is
called total returns to the variable factor.
TP = ∑ MP
Marginal Product (MP): Marginal product refers to change in total product when one more
units of the variable factor is used (fixed factors remaining constant).
𝐌𝐏𝐧 = 𝐓𝐏𝐧 – 𝐓𝐏𝐧-1
Average Product: Average product is output per unit of the variable factor.
AP = 𝐓𝐏/L
Returns to a Factor: Law of Variable Proportions
• Law of Variable Proportions stats that as more and more of the variable factor is combined
with the fixed factor, marginal product of the variable factor may initially rise (total output
increases at an increasing rate), but eventually a situation must come when marginal
product of the variable factor starts declining (total output increases only at a diminishing
rate).
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• A stage may come when MP becomes zero or even negative (total product starts
decreasing).
• Also known as ‘Law of Diminishing Marginal Product’.
Assumptions:
1. Ratio in which factors are combined can be changed.
2. Units of the variable factor are homogeneous or equally efficient and are increased one
by one.
3. State of technology remains constant.
Observations:
1. When more and units of labour are used, MP tends to rise till 3 units of labour. In this
situation, TP increases at an increasing rate. This is the situation of increasing returns to a
factor.
2. When 4th unit of labour is applied, MP starts decreasing. Now TP increases at diminishing
rate. This is the situation of diminishing returns.
3. Total Product is maximum when MP becomes zero.
4. TP starts decreasing when MP becomes negative, This is the situation of negative returns.
Observations:
1. When MP increases, TP increases at increasing rate.
2. When MP decreases, TP increases at diminishing rate.
3. When MP is zero, TP is maximum.
4. When MP becomes negative, TP starts decreasing.
5. Point of Inflexion: It is the point where slope of TP changes. Up to this point, TP has been
increasing at an increasing rate. From this point onwards TP increases, but only at a
diminishing rate.
Causes of Increasing Returns to a Factor:
1. Fuller Utilisation of the Fixed Factor: In the initial stages, fixed factor remains
underutilized. Its fuller utilization calls for greater application of the variable factor. Hence,
initially additional units of the variable factor increases MP.
2. Division of Labour and Increase in Efficiency: Additional application of variable factor
enables process-based division of labour. It increases productivity of variable factor. So, MP
increases.
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3. Better Coordination between the Factors: So long as fixed factor remains underutilized,
additional application of the variable factor tends to improve the degree of coordination
between the fixed and variable factors. As a result, MP increases.
Causes of Diminishing Returns to a Factor:
1. Fixity of the Factor: As more and more units of the variable factor are combined with the
fixed factor, the latter gets excessively utilized. It suffers greater wear and tear and losses
efficiency. Hence, the diminishing returns.
2. Imperfect Factor Substitutability: Factors of production are imperfect substitutes of each
other. More and more of labour cannot be continuously used in place of capital.
3. Poor Coordination between the Factors: Increasing application of the variable factor
eventually disturbs the ideal factor ratio. This results in poor coordination. Hence, the
diminishing returns.
Postponement of the Law:
1. When there is improvement in technology. Greater output is achieved with the same
inputs.
2. When some substitute of the fixed factor is discovered.
Relationship between TP and MP
1. So long as MP is increasing, TP is increasing at an increasing rate.
2. When MP starts diminishing, TP increases at a diminishing rate.
3. When MP – 0, there is no addition to TP. TP is maximum.
4. When MP is negative, TP starts declining.
5. MP is the rate of TP. Increasing MP implies that TP is increasing at an increasing rate.
Diminishing MP implies that TP is increasing at a diminishing rate. Zero MP implies that TP
stops increasing. Negative MP implies reduction in TP.
Relationship between AP and MP
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1. AP increases as long as MP > AP.
2. AP decrease when MP < AP.
3. AP is at its maximum when AP = MP.
4. MP may be zero or negative, but AP continues to be positive.
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