19.06.

2020 Production Lesson 21

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Law of Variable Proportions / Law of returns to a variable factor

Question 1

If more variable factors are employed to a given quantity of the fixed factors,
the total product may increase at an increasing rate initially but eventually it
will increase at a diminishing rate.
Explain the law with the help of a diagram. [6]

The law shows the nature of the rate of change in output due to a change in only one
variable factor of production. It is particularly applicable during the short-run when
a firm can change its output by changing only the variable factor while the fixed
factor remains unchanged.
[For understanding only]

 Statement

This law states that as more and more units of a variable factor are applied to the given
quantity of a fixed factor, the total product may increase at an increasing rate initially but
eventually it will increase at a diminishing rate.

 Assumptions

 The state of technology is given and it remains constant.

 It is assumed that some inputs are kept fixed while others are varied. It is only
that factor proportions can change.
 It is assumed that technology is such that is possible to change the factor
proportions.
 It is assumed that all units of the variable factor are homogeneous and equally
efficient.

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 Diagram

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 Explanation

Stage 1: Increasing returns to a variable factor

O to L2 units of labour:

When the rate of change in output is more than the rate of change in the variable factor, it
shows increasing returns to a variable factor.

 Initially TP increases at an increasing rate till point M upto OL1 units of labour and
subsequently increases at a diminishing rate. At point M where TP changes its slope is
(M)
known as the point of inflexion (I).

 MP initially rises, reaches its maximum at ‘M’ and then starts decreasing but remains
positive.

 AP increases throughout this stage and reaches its maximum at point A. In this stage
MP > AP. But at point A, MP = AP.

Stage 2: Diminishing returns to a variable factor

L2 to L3 units of labour:

When the rate of change in output is lesser than the rate of change in the variable factor, it
shows decreasing returns to a variable factor.

 TP continues to increase but at a diminishing rate and finally reaches its maximum at
point ‘T’ at the end of this stage.

 Continues to decrease and eventually becomes zero. At L3 units of labour, when TP is

MP
maximum, MP = 0.

 AP starts decreasing but remains positive. Here, MP < AP.

This is the most important stage as any rational producer would like to operate in this
stage.

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Stage 3: Negative returns to a variable factor

Beyond L3 units of labour:

 Here, TP declines with further increase in the variable factor. Hence, the TP curve
slopes downward after point ‘T’.

 As TP starts declining, the MP of the variable factor becomes negative.

 AP continues to fall but remains positive.

STAGE OF OPERATION:

A rational producer will never produce in Stage-1, because he will not be fully utilising
the opportunities of increasing production.

He will also never produce in Stage-3 because it results in declining TP.

Stage 31isand
Therefore, Stages called as called
3 are the Stage
theofStages
Economic Nonsense Absurdity.
of Economic or Economic Absurdity.

Thus, a rational producer will always want to produce in Stage-2.

Question 2

In which stage of production will a producer produce? Explain. [3/6]

 Diagram showing the three stages of the law of variable proportions to be drawn.

 Of the three stages of production, a firm would like to produce in Stage 2.

 A rational producer would never like to operate in Stage 1, since the AP of the
variable factor (labour) is increasing throughout the stage. The firm has an
incentive to employ more of the variable factor throughout Stage 1 because it
helps the producer to increase the AP, decrease the average cost and thus
increase its profit.

If the producer stops before Stage 1, it means that he is not taking full advantage of
the constantly rising productivity of the variable factor.

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  A rational producer would not operate in Stage 3 as MP of the variable factor is
negative. Therefore, a producer can increase the total product by employing less
of the variable factor. A firm would never incur expenditure in employing an
additional worker if it results in decrease of total output. Stage 3 is therefore,
called as the Stage of Economic Absurdity or Economic Nonsense.

 Thus, by the process of elimination we can conclude that a rational producer

would operate in Stage 2.

[For a 6 mark question, apart from the above explanation, each stage has to be
explained mentioning the behavior of TP, AP and MP]

Question3

Explain two causes each of increasing returns, diminishing returns and negative
returns to a variable factor. [3/6]

 Causes for Increasing Returns

 Fuller utilisation of the fixed factors

During the first stage when more variable factors (labour) are employed to
increase the output, then the fixed factors (machines) can be utilized more
efficiently. Hence, the output can be increased at an increasing rate.

Example: If 5 machines are essential for producing a commodity, at least 5

labourers are needed to operate these 5 machines. If less workers are used some
machines will remain unutilized.

 Division of Labour

As units of the variable factor are increased in Stage 1, the efficiency of the
variable factor also increases due to division of labour and specialization. With
more labourers it becomes possible to divide the work amongst them according to
their skill and aptitude.

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 Causes for Diminishing Returns

 Disturbing the optimum proportion

There is an optimum combination of the fixed and variable factors. If more than
the optimum level of variable factor is employed to a given amount of fixed
factor, it leads to a fall in the marginal and average product.

Example: If the optimum capital-labour ratio is 1:5. Thus, if more than 5 labourers
are employed, this combination is disturbed.

 Imperfect Substitutability of factors of production

Different factors of production like labour and capital are not perfect substitutes.
Thus, when more and more labourers are employed, they may not be able to
perform the same work as it would have been possible with extra amount of
capital. As a result, there would be diminishing returns to a variable factor.

 Causes for Negative Returns

 Overcrowding and machine breakdown

If we keep on adding more of the variable factors to a given quantity of the fixed
factor, it will lead to overcrowding. There will be lower availability of tools and
equipments leading to fall in productivity.
If the firm goes on employing more and more of the variable factor, keeping plant
and machinery unchanged, then incidences of machine breakdown will arise.

 Inefficient Management/Management Problems

Use of too much of the variable factor results in problems of effective

management. There may be growing tendency of neglecting the duties of the
workers. As a result, there will be decrease in their efficiency leading to negative
returns to a variable factor.

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Question4

Explain the three possibilities of Returns to a Factor. [2/3]

 Increasing Returns to a Factor

When the rate of change in output is more than the rate of change in the variable
factor, it shows increasing returns to a variable factor.

It means each additional unit of the variable factor adds more and more to the total
output and when marginal product of a factor increases.

 Constant Returns to a Factor

When the rate of change in output is equal to the rate of change in the variable factor,
it shows constant returns to a variable factor.

It means each additional unit of a variable factor adds the same amount to the total
output i.e. when marginal product of the variable factor is constant.

 Diminishing Returns to a Factor

When the rate of change in output is lesser than the rate of change in the variable
factor, it shows decreasing returns to a variable factor.

It means each additional unit of the variable factor adds lesser to the total output and
when marginal product of the factor increases.

Question 5

Define the Law of Returns to Scale. [2]

When all inputs are changed in the same proportion, it is referred to as a change in the
scale of production. The way total output changes due to change in the scale of production
is known as the ‘law of returns to scale’.
It is a long-run phenomenon.

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 Returns to a variable factor Returns to scale

The law of returns to a variable factor is The law of returns to scale is associated
associated with the notion of short-run with the notion of long-run production
production function. function.
This law refers to the rate of change in This law refers to the rate of change in
output in response to a change in any one output in response to a change in all
variable factor (say, labour), while other variable factors.
factors of production remain unchanged.
In this case, the factor proportions are In this case, K/L ratio remains unchanged,
changed, i.e., K/L ratio changes. since both K and L are increased by same
percentages (say, 10 per cent).

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