law of variable proportions and law of returns to scale
DESCRIPTION
This presentation puts emphasis on Law of Variable proportion and Law of Returns to Scale It also puts light on production function, cost function, etc.TRANSCRIPT
Done byAmara Bandukada
Umme BabaAyush Parekh
Suchit ChauhanArul Collins
A1 Batch
LAW OF VARIABLE PROPORTIONS
&LAW OF RETURNS TO
SCALE
Introduction
What is Economics?• Economics is the study of the • production and consumption of goods• transfer of wealth to produce and obtain those
goods.
• Economics explains how people interact within markets to get what they want or accomplish certain goals.
Macroeconomics
Macroeconomics contains broader view by analyzing the economic activity of an entire country or the international marketplace.
Microeconomics focuses on the actions of individuals and industries, like the dynamics between buyers and sellers, borrowers and lenders.
Types of EconomiesMicroeconomics
Production Function
• A production function is an equation, table or graph, which specifies the maximum quantity of output, which can be obtained, with each set of inputs.
• Prof. Richard H. Leftwich states that production function refers to the relationship between inputs and outputs at a given period.
(Inputs = resources such as land, labor, capital and organization used by a firm
Outputs = goods or services produced by the firm)
• It is written as Q = F(X1, X2… Xn). • Where Q is the maximum quantity of output and X1, X2,… Xn are the
quantities of the various inputs. If there are only two inputs, labor L and capital K, we write the equation as Q = F(L,K).
• The concept of production function stems from the following two things:• 1. It must be considered with reference to a particular period.• 2. It is determined by the state of technology. Any change in technology
may alter output, even when the quantities of inputs remain fixed.
• Total Product : It is the total output or quantity that is produced by a firm using fixed and variable factors at a given point of time.
• Average Product : It is defined as the product produced per unit of variable input employed when fixed inputs are held constant.
Average Product = (Total Product) / (Variable Inputs Employed)
• Marginal Product : It is defined as the change in total product that comes as a result of a one unit increase in the variable input.
Marginal Product = (dTP) / (dVI)(where TP is total product and VI is variable inputs. )
Total, Average & Marginal Product
Lawof
VariableProportions
Prof. Marshall stated, “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 of the LawOnly one variable factor unit is to be varied
while all other factors should be kept constant
Different inits of variable factor are homogenous
Techniques of production remain constantThe law will hold good only short and a given
periodThere are possibilities of varying the
proportion of factor inputs.
Diminishing returns arise due to the following :-The proportion of variable factors is greater
than the quantity of fixed factors. Hence both AP and MP decline.
Total output diminishes because there is a limit to the full utilization of indivisible factors and introduction of specialization. Hence Output declines.
Imperfect suitability 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.
Lawof
Returns to Scale
The law of returns to scale examines the relationship between output and the scale of inputs in the long-run when all the inputs are
increased in the same proportion.
All the factors of production (such as land, labor and capital) but organization are variable
The law assumes constant technological state. It means that there is no change in technology during the time considered
The market is perfectly competitive
Outputs or returns are measured in physical terms.
Assumptions
•The law of increasing returns
• The law of constant returns
•The law of decreasing returns
Three Stages of Returns to Scale
Unit Scale of Production Total Returns Marginal Returns
1 1 Labor + 2 Acres of Land 4
4 (Stage I - Increasing Returns)
2 2 Labor + 4 Acres of Land 10 6
3 3 Labor + 6 Acres of Land 18 8
4 4 Labor + 8 Acres of Land 28 10 (Stage II -
Constant Returns)
5 5 Labor + 10 Acres of Land 38 10
6 6 Labor + 12 Acres of Land 48 10
7 7 Labor + 14 Acres of Land 56
8 (Stage III - Decreasing Returns)
8 8 Labor + 16 Acres of Land 62 6
Production function
v/sCost
function
Production function A production function relates
physical output of a production process to physical inputs or factors of production
Cost function The cost-of-production theory
of value is the theory that the price of an object or condition is determined by the sum of the cost of the resources that went into making it. The cost can comprise any of the factors of production (including labor, capital, or land) and taxation.
Total Cost Total cost in economics
includes the total opportunity cost of each factor of production as part of its fixed or variable costs.
The total product (or total physical product) of a variable factor of production identifies what outputs are possible using various levels of the variable input
Total Cost v/s Total ProductTotal Product
Average cost Average cost or unit cost is
equal to total cost divided by the number of goods produced (the output quantity, Q). It is also equal to the sum of average variable costs (total variable costs divided by Q) plus average fixed costs (total fixed costs divided by Q)
Average product is the per unit production of a firm. Conceptually, it is simply the arithmetic mean of total product calculated for each variable input over a whole range of variable input quantities
Average Cost v/s Average Product
Average Product
Marginal cost Marginal cost is the change in the
total cost that arises when the quantity produced has an increment by unit. That is, it is the cost of producing one more unit of a good. In general terms, marginal cost at each level of production includes any additional costs required to produce the next unit
The marginal product of an input (factor of production) is the extra output that can be produced by using one more unit of the input (for instance, the difference in output when a firm's labor usage is increased from five to six units), assuming that the quantities of no other inputs to production change
Marginal cost v/s Marginal product
Marginal product
Summary
Law of Variable Proportions
Short periodOnly one factor is varied The factor ratio remains
changedThere are three stages:
a) Increasing returns to factor. b) Diminishing returns to factor c) Negative returns to factor
Productions is of variable type
Long period All factors varied The factor ratio remains
unchanged There are three stages: a) Increasing returns to
scale b)Decreasing returns to
scale c)Constant returns to scale
Productions is of constant type
Difference between the LawsLaw of Returns to Scale
SHORT RUN• Short run is defined as a period when production
can be increased only with increase in variable factors .
LONG RUN• Long run is defined as a period which allows the firm
to change their sizes and scales to increase output
SHORT RUN• The short run as the time horizon over which the scale of
operation is fixed and the only available business decision is the number of workers to employ.
• Quantity of labor is variable but quantity of capital and production processes are fixed
LONG RUN• The long run as time horizon is needed for a producer to
have flexibility over all relevant production decisions• Long run: Quantity of labor, quantity of capital, and
production processes are all variable
Production Decisions
SHORT RUN• In the short run, firms have already chosen whether to
be in business and at what scale and technology of production.
• The number of firms in an industry is fixed
LONG RUN• In the long run, firms have the flexibility to fully enter
or exit an industry.• The number of firms in an industry is variable since
firms can enter and exit
Market Entry and Exit
SHORT RUN• Firms will produce if the market price at least covers
variable costs, since fixed costs have already been paid and, as such, don't enter the decision-making process.
• Firms' economic profits can be positive, negative or zero.
LONG RUN• Firms will enter a market if the market price is high enough to
result in positive economic profit.• Firms will exit a market if the market price is low enough to result
in negative economic profit.• If all firms have the same costs, firm profits will be zero in the
long run in a competitive market
Market Behavior
Conclusion
It is helpful in understanding clearly the process of production.
The law tells us that the tendency of diminishing returns is found in all sectors of the economy .
The law tells us that any increase in the units of variable factor will lead to increase in the total product at a diminishing rate.
Law of Variable Proportions
This law may not apply universally to all kinds of productive activities .
This law has been found to operate in agricultural production more regularly than in industrial production.
If increasing units of an input are applied to the fixed factors, the marginal returns to the variable input decrease eventually.
Law of Returns to Scale