THE LAW OF VARIABLE PROPORTION IS ALSO KNOWN AS THE LAW OF RETURNS.

THIS LAW DESCRIBES THE BEHAVIOUR OF THE SHORT-RUN PRODUCTION FUNCTION.

IT STATES THAT AS WE INCREASE THE AMOUNT OF VARIABLE FACTOR KEEPING THE AMOUNT OF FIXED FACTORS CONSTANT, FIRST THE AVERAGE PRODUCT RISES, THEN IT STARTS FALLING & FINALLY, AN ADDITIONAL UNIT OF VARIABLE FACTOR RESULTS INTO A FALL IN THE TOTAL OUTPUT, i.e. THE MARGINAL PRODUCT OF VARIABLE FACTOR BECOMES NEGATIVE.

THUS, THE LAW DESCRIBES THREE STAGES NAMELY,

1] STAGE – I (STAGE OF INCREASING RETURNS)

2] STAGE – II (STAGE OF DIMINISHING RETUNS) &

3] STAGE – III (STAGE OF NEGATIVE RETUNS)

THE LAW OF RETURNS TO SCALE

THIS LAW DESCRIBES THE BEHVIOUR OF A LONG-RUN PRODUCTION FUNCTION. IT STATES THAT AS WE INCREASE ALL THE FACTORS OF PRODUCTION IN A GIVEN PROPORTION, FIRST OUTPUT INCREASES MORE THAN PROPORTIONATELY, THEN IT INCREASES PROPORTIONATELY AND LASTLY, IT INCREASES LESS THAN PROPORTIONATELY.

FOR EXAMPLE, WE INCREASE ALL THE INPUTS BY 10%, OUTPUT INCREASES BY MORE THAN 10%, SAY BY 15% OR 20%. THEN IT RISES BY 10% AND LASTLY, INCREASE IN ALL THE INPUTS BY 10% RESULTS INTO LESS THAN 10% RISE IN THE OUTPUT.

THUS, THE LAW OF RETURNS TO SCALE DESCRIBES THE THREE STAGES,

1] STAGE – I (STAGE OF INCREASING RETURNS TO SCALE)

2] STAGE – II (STAGE OF CONSTANT RETURNS TO SCALE)

3] STAGE – III (STAGE OF DIMINISHING RETURNS TO SCALE)

THESE THREE STAGES CAN BE EXPLAINED WITH THE HELP OF ECONOMIES OF SCALE.

THE CONCEPT OF ECONOMIES OF SCALE MEANS, AS WE INCREASE THE SCALE i.e. THE LEVEL OF OUTPUT, THE AVERAGE COST OF PRODUCTION FALLS DUE TO CERTAIN ADVANTAGES ASSOCIATED WITH LARGE-SCALE PRODUCTION.

THESE ECONOMIES OF SCALE ARE OF TWO TYPES;

1) INTERNAL ECONOMIES OF SCALE

2) EXTERNAL ECONOMIES OF SCALE

INTERNAL ECONOMIES OF SCALE ARE THOSE ADVANTAGES WHICH ARE ENJOYED BY THE FIRM THAT EXPANDS. SO. INTERNAL ECONOMIES OF SCALE ARE FIRM-SPECIFIC.

EXTERNAL ECONOMIES OF SCALE ARE NOT FIRM-SPECIFIC. THEY ARE ENJOYED BY ALL THE FIRMS IN THE INDUSTRY AS A RESULT OF EXPANSION.

INTERNAL ECONOMIES OF SCALE

1. SPECIALISATION & DIVISION OF LABOUR

2. MANAGERIAL ECONOMIES

3. FINANCIAL ECONOMIES

4. MARKETING ECONOMIES

5. LEARNING CURVE EFFECT

6. TECHNICAL ECONOMIES

7. PRODUCTION ECONOMIES

EXTERNAL ECONOMIES OF SCALE

1. ECONOMIES OF CONCENTRATION

2. ECONOMIES OF INFORMATION

3. ECONOMIES OF DISINTEGRATION

A FIRM IS BENEFITED BY BOTH INTERNAL AND EXTERNAL ECONOMIES OF SCALE ONLY UPTO A POINT. THEREAFTER, A FURTHER INCREASE IN THE VOLUME OF OUTPUT STARTS PRODUCING DISECONOMIES OF SCALE.

EVEN DISECONOMIES OF SCALE ARE ALSO INTERNAL AS WELL AS EXTERNAL.

INTERNAL DISECONOMIES OF SCALE ARE IN THE FORM OF LACK OF PROPER CONTROL OR DISCIPLINE, MISMANAGEMENT, MORE REGULATION OR RESTRICTIONS BY THE GOVERNMENT, GREATER PRESSURE FROM TRADE UNIONS, SUPPLIERS ETC.

EXTERNAL DISECONOMIES OF SCALE ARISE AS A RESULT OF OVER-CROWDED AREA, NON-AVAILABILITY OF THE REQUIRED RAW-MATERIAL, ELECTRICITY, COMPONENTS ETC. IN SUFFICIENT QUANTITY, DELAY IN TRANSPORT AND SO ON AND SO FORTH.

EXAMPLES

Q. 5 IF PRODUCTION IS GIVEN BY Q = -L3/3 + 2L2 + 12L BEYOND WHAT POINT DIMINISHING RETURNS SETS IN ?

Q. 6 WITH RESPECT TO THE PRODUCTION FUNCTION IN THE ACCOMPANYING TABLE

1] INDICATE WHETHER WE HAVE INCREASING, CONSTANT OR DIMINISHING RETURNS TO SCALE.

2] IS THE LAW OF DIMINISHING RETURNS OPERATING ?

Chapter : COST ANALYSIS

COST CAN BE DEFINED AS A COMPENSATION, CASH OR KIND, MADE BY A FIRM TO A FACTOR OF PRODUCTION FOR ITS CONTRIBUTION TO THE PRODUCTION PROCESS.

CLASSIFICATION OF COST

FIXED COST

IT IS THE COST INCURRED ON FIXED FACTORS. IN THE SHORT-RUN, THIS COST REMAINS CONSTANT WHATEVER MAY BE THE LEVEL OF OUTPUT. IT IS THE SAME EVEN WHEN OUTPUT IS ZERO. e.g. RENT OF THE PREMISES, SALARY OF THE WATCHMAN etc.

VARIABLE COST

IT IS THE COST THAT DEPENDS ON THE VOLUME OF OUTPUT PRODUCED. WHEN OUTPUT IS ZERO, VARIABLE COST IS ALSO ZERO e.g. COST OF RAW-MATERIAL, ELECTRICITY, WAGES OF THE WORKERS OPPOINTED ON PIECE-WAGE RATE etc.

TOTAL COST = TOTAL FIXED COST + TOTAL VARIABLE COST

TOTAL FIXED COST CURVE IS A HORIZONTAL LINE. IT IS CONSTANT WHATEVER MAY BE THE LEVEL OF OUTPUT.

TOTAL VARIABLE COST CURVE

IT INCREASES FIRST AT A DIMINISHING RATE & THEN IT STARTS INCREASING AT INCREASING RATE.

TOTAL COST CURVE LIKE TVC CURVE, IT RISES AT A DIMINISHING RATE FIRST AND THEN AT AN INCREASING RATE.

THE VERTICAL DISTANCE BETWEEN TC CURVE & TVC CURVE IS CONSTANT, AS IT REPRESENTS TFC

AFC CURVE

IT CONTINUOUSLY APPROACHES X – AXIS

IT NEVER MEETS X – AXIS.

AVC CURVE

IT IS U - SHAPED

AC CURVE

IT IS ALSO U – SHAPED

AS IT MOVES FROM LEFT TO RIGHT, IT COMES CLOSER & CLOSER TO AVC CURVE

MC CURVE

MC CURVE IS U – SHAPED

IT CUTS AC CURVE AT ITS LOWEST POINT

EXERCISE - I

A FIRM USES 5 MACHINES OF Rs. 5000 EACH. IT EMPLOYS INCREASES THE

NUMBER OF WORKERS BY PAYING Rs. 5000 TO EACH OF THEM. THE MARGINAL

PRODUCT OF SUCCESSIVE WORKERS ARE GIVEN BELOW;

WORKER MP

1 10

2 15

3 20

4 5

5 0

PREPARE TABLE SHOWING TFC, TVC, TC AND AC AT DIFFERENT LEVELS OF OUTPUT AND SHOW THAT AC FIRST FALLS AND THEN IT STARTS RISING.

EXERCISE – 2

IN THE LONG-RUN A FIRM KEEPS EXPANDING ITS PRODUCTION BY

EMPLOYING MORE MACHINES AND WORKERS. THE COST OF EVERY MACHINE

IS Rs. 10,000 & WAGE-RATE FOR THE WORKERS IS Rs. 1000. INCREASE IN

OUTPUT WITH INCREASE IN CAPITAL AND LABOUR IS GIVEN IN THE FOLLOWING TABLE.

MACHINES WORKERS OUTPUT

1 2 600

2 4 1500

4 8 3200

8 16 6400

16 32 9600

32 64 15360

PREPARE TABLE SHOWING TC & AC AT DIFFERENT LEVELS OF OUTPUT.

GIVE YOUR COMMENT.

Chapter : ECONOMIC COST & ECONOMIC PROFIT

FOR AN ACCOUNTANT, INFLOW OR OUTFLOW OF FUND IN THE BUSINESS

IS IMPORTANT. HENCE ONLY EXPLICIT COST FINDS PLACE IN ACCOUNTING COST, WHEREAS FOR AN ECONOMIST EXPLICIT AS WELL AS IMPLICIT COST IS

IMPORTANT. ECONOMIC COST INCLUDES OPPORTUNITY COST, WHICH DOES NOT FIND PLACE IN ACCOUNTING COST.

PROFIT = REVENUE – COST, SINCE THERE IS DIFFERENCE BETWEEN ACCOUNTING COST AND ECONOMIC COST, THERE IS DIFFERENCE BETWEEN ACCOUNTING PROFIT AND ECONOMIC PROFIT.

ACCOUNTING PROFIT = REVENUE – COST (ONLY EXPLICIT COST)

ECONOMIC PROFIT = REVENUE – COST (EXPLICIT AND IMPLICIT / OPPORTUNITY COST)

IN ECONOMICS, THERE IS YET ANOTHER PROFIT CONCEPT, NAMELY NORMAL PROFIT .

NORMAL PROFIT IS THE MINIMUM RETURNS EXPECTED BY THE PRODUCER.

IT IS THE SUM TOTAL OF ALL THE IMPLICIT AND OPPORTUNITY COSTS.

WHEN THE PRODUCER EARNS ONLY NORMAL PROFIT, HIS ECONOMIC PROFIT IS ZERO.

WHEN ECONOMIC PROFIT IS POSITIVE, IT MEANS THE FIRM IS ENJOYING SUPER-NORMAL PROFIT .

EX. 1 HEENA, A HOUSEWIFE ALSO TAKES TUITION @ Rs.100 PER HOUR. WHILE

WHILE IN DUBAI IN THE SUMMER HOLIDAYS, SHE BOUGHT SOME DRESS-

MATERIAL FOR WHICH SHE PAID Rs.50 PER METER. THIS MATERIAL COULD

BE SOLD BACK TO LOCAL FABRIC SHOP IN MUMBAI @ Rs.150 PER METER.

HEENA IS CONSIDERING USING THAT MATERIAL TO MAKE DRESSES, WHICH

SHE WOULD SELL TO HER FRIENDS AND NEIGHBOURS. SHE ESTIMATES THAT

EACH DRESS WOULD REQUIRE 4 METERS OF MATERIAL AND 4 HOURS OF

TIME. IF THE DRESSES COULD BE SOLD FOR Rs.900 EACH, COULD HEENA

EARN POSITIVE ECONOMIC PROFIT BY MAKING AND SELLING DRESSES?

HEENA COULD NOT MAKE POSITIVE ECONOMIC PRFIT BY MAKING AND

SELLING DRESSES.

EX. - 2 KISHOR GENERALLY SPENDS HIS SUMMERS WORKING ON THE COLLEGE

MAINTENANCE CREW AT A WAGE RATE OF Rs.60 PER HOUR FOR A

40-HOUR WEEK. OVERTIME WORK IS ALWAYS AVAILABLE AT AN HOURLY RATE OF 1.5 TIMES THE REGULAR WAGE RATE. FOR THE COMING SUMMER, HE IS OFFERRED THE PIZZA STAND CONCESSION

AT THE STUDENTS’ UNION BUILDING, WHICH WOULD HAVE TO BE OPEN 10 HRS. PER DAY, 6 DAYS A WEEK. HE ESIMATES THAT HE CAN SELL 100 PIZZAS A WEEK AT Rs.60 EACH. THE PRODUCTION COST OF

EACH PIZZA IS Rs.20 & THE RENT ON THE STAND IS Rs. 1500 PER WEEK. WHAT SHOULD KISHOR DO?

IF KISHOR TAKES PIZZA STAND, HIS ACCOUNTING PROFIT WOULD BE;

EX. - 3 A RECENT ENGINEERING GRADUATE TURNS DOWN A JOB OFFEER OF Rs.3,00,000

PER YEAR & STARTS HIS OWN BUSINESS. HE WILL INVEST Rs.5,00,000 OF HIS OWN MONEY IN THE BANK A/C EARNING 7% INTEREST PER YEAR. HE ALSO PLANS TO USE HIS BUILDING HE OWNS IN KOLKATA THAT HAS BEEN RENTED FOR

Rs.15000 per month. REVENUE IN NEW BUSINESS DURING THE FIRST YEAR WAS

Rs. 10,50,000 WHILE EXPENSES WERE;

ADVERTISING Rs. 50,000

TAXES Rs.50,000

EMPLOYEES’ SALARY Rs.4,00,000

SUPPLIES Rs. 50,000

PREPARE TWO INCOME STATEMENTS, ONE USING TRADITIONAL ACCOUNTING APPROACH & THE OTHER USING OPPORTUNITY COST APPROACH TO DETERMINE

PROFIT.

SOLUTION – 3 ACCOUNTING APPROACH

EX. - 4 SWASTIK ELECTRONICS LTD. HAS AN INVENTORY OF 5000 ELECTRONIC CHIPS ORIGINALLY PURCHASED FOR Rs.25 EACH; THEIR MKT. VALUE NOW

IS Rs.50 EACH. THE PRODUCTION DEPARTMENT HAS PROPOSED TO USE

THESE CHIPS BY PUTTING EACH ONE TOGETHER WITH Rs.60 WORTH OF

LABOUR & OTHER MATERIALS TO PRODUCE A WRISTWATCH THAT WOULD BE SOLD FOR Rs.100 EACH. SHOULD THIS PROPOSAL BE ACCEPTED? EXPLAIN.

SOLUTION - 4

Chapter : PERFECT COMPETITION

A LARGE NUMBER OF BUYERS & SELLERS.

PRODUCT SOLD BY ALL THE FIRMS IN THE INDUSTRY IS HOMOGENEOUS.

THERE IS FREE ENTRY & EXIT FOR THE FIRM.

THERE IS PERFECT KNOWLEDGE ABOUT MARKET CONDITION ON THE PART

OF BUYERS & SELLERS.

FACTORS OF PRODUCTION ARE PERFECTLY MOBILE.

TRANSPORT COST IS ASSUMED TO BE ABSENT.

THERE IS NO GOVERNMENT INTERVENTION.

SHUT-DOWN POINT

IF IN THE SHORT-RUN A FIRM IN PERFECT COMPETITION CAN NOT COVER ITS TOTAL COST i.e. ITS TOTAL COST IS GREATER THAN TR, IT HAS TWO OPTIONS;

1] TO SHUT-DOWN THE FIRM IMMEDIATELY.

2] TO CONTINUE TO CARRY ON ITS BUSINESS EVEN AT A LOSS AND WIND-UP

THE BUSINESS AND QUIT THE INDUSTRY IN THE LONG-RUN.

IF A FIRM SHUTS DOWN ITS PRODUCTION, IT CAN NOT QUIT THE INDUSTRY IN THE SHORT-RUN. HENCE DURING THAT PERIOD FIXED COST IS INCURRED. THUS, BY SHUTTING DOWN PRODUCTION ITS LOSS BECOMES EQUAL TO TFC.

THEREFORE, A LOSS-MAKING FIRM DECIDES TO SHUT DOWN ONLY IF ITS LOSS IS GREATER THAN TFC. FOR EXAMPLE,

TFC = Rs. 200000, TVC = Rs. 100000 & TR = Rs. 2,50, 000.

IN THIS CASE, TC = Rs. 300000 & TR = Rs. 2,50,000 SO, LOSS = Rs. 50,000 .

IF THE FIRM DECIDES TO SHUT DOWN, ITS LOSS WILL BE EQUAL TO TFC

i.e. Rs. 200000. IT IS BETTER TO CARRY ON THE PRODUCTION IN THE SHORT-RUN

BUT QUIT THE INDUSTRY IN THE LONG-RUN.

THEREFORE, IF A FIRM’S TR COVERS THE TVC & PARTLY TFC, IT DOES NOT SHUT DOWN. BUT IF ITS TR IS LESS THAN TVC, IT IS BETTER TO SHUT DOWN.

FOR EXAMPLE,

TFC = Rs. 200000, TVC = Rs. 100000 & TR = Rs. 90,000

SO LOSS = Rs. 2,10,000. IF IT SHUTS DOWN, ITS LOSS WILL REDUCE TO Rs. 200000

WHICH IS NOTHING BUT THE TOTAL FIXED COST (TFC)

LET US SEE THE DIAGRAMIC REPRESENTATION OF SHUT - DOWN POINT

Chapter : MONOPOLY

THE TERM ‘MONOPOLY’ IS DERIVED FROM GREEK WORDS. ‘MONO’ MEANS

SINGLE AND ‘POLY’ MEANS SELLER. MONOPOLY REFERS TO THE MARKET WHERE THERE IS A SINGLE SELLING THE PRODUCT THAT DOES NOT HAVE A CLOSE SUBSTITUTE.

IT MAY BE A SINGLE FIRM OR A PARTNERSHIP FIRM OR A JOINT-STOCK COMPANY.

FEATURES OR CHARACTERISTICS OF MONOPOLY :

SINGLE SELLER HAS COMPLETE CONTROL OVER THE SUPPLY OF THE COMMODITY.

THERE ARE NO CLOSE SUBSTITUTES.

THERE IS NO FREE ENTRY OR EXIT BECAUSE OF SOME RESTRICTIONS.

THERE IS COMPLETE NEGATION OF COMPETITION.

MONOPOLIST IS A PRICE – MAKER.

THERE IS NO DIFFERENCE BETWEEN FIRM AND INDUSTRY.

MONOPLIST FACES A DOWNWARD SLOPING DEMAND CURVE. IT MEANS HE CAN

SELL MORE ONLY AT A LOWER PRICE.

TYPES / KINDS OF MONOPOLY

1. PERFECT MONOPOLY : IT IS ALSO CALLED ABSOLUTE MONOPOLY.

THERE IS NO REMOTE SUBSTITUTE ALSO. COMPETITION IS ZERO. PRACTICALLY, SUCH TYPE OF MONOPOLY HARDLY EXISTS.

2. IMPERFECT MONOPOLY : IT IS ALSO CALLED LIMITED MONOPOLY. THE PRODUCT SOLD HERE DOES NOT HAVE CLOSE SUBSTITUTE, BUT IT MAY HAVE A REMOTE SUBSTITUTE.

3. PRIVATE MONOPOLY : IT IS OWNED, CONTROLLED AND MANAGED BY THE INDIVIDUAL OR A PRIVATE BODY OR PRIVATE ORGANIZATION. IT IS ALWAYS PROFIT-ORIENTED.

4. PUBLIC MONOPOLY : IT IS OWNED, CONTROLLED AND MANAGED BY THE GOVERNMENT. IT IS WELFARE OR SERVICE – ORIENTED.

5. SIMPLE MONOPOLY : UNDER THIS TYPE OF MONPOLIST CHARGES

UNIFORM PRICE FROM ALL THE BUYERS.

6. DISCRIMINATING MONOPOLY : MONPOLIST CHARGES DIFFERENT PRICES FROM DIFFERENT CUSTOMERS, DEPENDING ON ELSTICITY OF DEMAND.

7. LEGAL MONOPOLY : THERE ARE LEGAL RESTRICTIONS ON NEW ENTRY. THIS IS

DONE THROUGH PATENT, COPYRIGHTS, TRADE MARKS, STATUTORY REGULATIONS

ETC.

8. NATURAL MONOPOLY : IT IS DUE TO SOME NATURAL FACTORS LIKE LOCATION,

AVAILABILITY OF NATURAL RESOURCES ETC.

9. TECHNOLOGICAL MONOPOLY : MONOPOLY POWER IS GAINED AS A RESULT OF RETURNS TO SCALE, SOPHISTICATED TECHNOLOGY ETC.

10. JOINT MONOPOLY : SOME TIMES A FEW FIRMS OR COMPANIES COME TOGETHER AND FORM AMALGAMATION, CARTELS OR SYNDICATES IN ORDER ENJOY MONOPOLY POWER. GENERALLY, GOVERNMENT PUTS RESTRICTIONS ON SUCH

A MONOPOLY.

PRICE DISCRIMINATION

MONOPOLIST IS A PRICE-MAKER. WHEN HE SELLS HIS PRODUCT AT DIFFERENT PRICES, IT IS CALLED PRICE DISCRIMINATION

THERE ARE THREE DEGREES OF PRICE DISCRIMINATION.

PRICE DISCRIMINATION OF FIRST DEGREE

UNDER THIS KIND OF PRICE DISCRIMINATION, THE MONOPOLIST SELLS EVERY UNIT OF THE PRODUCT AT DIFFERENT PRICE. IT IS THE PRICE THAT THE CUSTOMER IS WILLING TO PAY.

PRICE DISCRIMINATION OF SECOND DEGREE

SECOND DEGREE PRICE DISCRIMINATION REFERS TO ONE IN WHICH THE MONOPOLIST SELLS HIS OUTPUT IN DIFFERENT BLOCKS CHARGING DIFFERENT PRICE.

PRICE DISCRIMINATION OF THIRD DEGREE

INTERNATIONAL PRICE DISCRIMINATION – DUMPING

• Price discrimination in the area of foreign trade is called as ‘Dumping’.

• Here the seller is a monopolist in the home market and one of the many competitors in the foreign market.

• Hence he charges high price in the home market and low price in the foreign market thereby maximizing profits.

• It is also called persistent dumping.

DUMPING

Types of DUMPING

There are three types of Dumping;

PERSISTENT DUMPING.

PREDATORY DUMPING.

SPORADIC DUMPING

PERSISTENT DUMPING IS ONE WHICH IS ADOPTED BY THE EXPORTING COUNTRY IN ORDER TO MAXIMIZE ITS EXPORT EARNINGS. A HIGH ELASTICITY OF DEMAND IN THE INTERNATIONAL MARKET LEADS TO LOWER PRICE IN THE INTERNATIONAL MARKET & A LOW ELASTICITY OF DEMAND IN THE HOME MARKET LEADS TO HIGHER PRICE IN THE HOME MARKET.

PREDATORY DUMPING IS STRATEGY ADOPTED BY THE EXPORTING COUNTRY. OUTPUT IS EXPORTED AT A LOW PRICE IN ORDER TO DRIVE AWAY THE COMPETITORS & THEN TO INCREASE THE PRICE TO TAKE THE ADVANTAGE OF THE ABSENCE OF COMPETITION. THIS TYPE OF DUMPING IS HIGHLY OBJECTIONABLE.

SPORADIC DUMPING IS THE OCCASIONAL SALE OF COMMODITY AT A LOW OR BELOW THE COST. IT IS MAINLY TO UNLOAD UNFORESEEN & TEMPORARY SURPLUS OF A COMMODITY WITHOUT REDUCING DOMESTIC PRICES.