Economics – ISC Handbook of Economics - Laws of Returns – Quick Revision

6
QUICK
1. Production: Production means the creation of goods or performance of services for sale in the market.
2. Production Function: The functional relationship between physical inputs and physical output of a firm is
called production function.
or
Production function means functional relationship between inputs used and resulting output.
Qx = f(L, L and K, E)
3. Types of Production Function: There are two types of production functions, vis.,
(i) Short-run Production Function: It refers to production in the short-run where some factors remain fixed
and others variable. In short-run, product increases when more units of variable factors are used with the
fixed factors. This is known as returns to a variable factors or law of variable proportions.
Qx = f(L, ~K)
(ii) Long-run Production Function: It refers to production in a time period when all factors are variable. The
effects of the changes in all the inputs on total output are called returns to scale or long-run production
function.
Qx = (1, K ...)
4. Factors of Production: Various factors of production are classified into two categories: fixed factors and
variable factors.
Fixed factors are those factors of production whose quantity remains fixed (or unchanged) at different levels
of output, e.g., factory, building, machines, etc.
Variable factors refer to those factors of production which vary with every level of output, e.g., raw material
ordinary labour power, fuel, etc.
In the short-run, only the quantity of variable factors can be changed while all the factors of production
become variable in the long-run.
5. Concepts of Product: Generally, there are three main concepts of product which are used in context of
input-output relations. These are:
(i) Total Product/Total Physical Product: It is defined as the total quantity of goods and services produced
by a firm with the given inputs during a specified period of time. Total product is sum of total output of each
unit of variable factor used in the process of production. Thus,
TP = Sum of MPs
TP = APXn
(ii) Marginal Product: It is a net addition to total product when one more unit of variable factors employed.
MP = TPn - TPn -1
MP = ΔTP/ ΔL

,(iii) Average Product: It is the per unit production of the variable factors, i.e.,
AP = TP/L


6.Law of Variable Proportions Of Returns to Factor: It states that as more and more units of a variable factor
are applied to a 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:
(i) The law applies only in the short-run.
(ii) One factor of production is variable and others are fixed.
(iii) All units of variable factor are homogeneous.
(iv) State of technology is given and remains the same.
(v) Factor proportions can be changed.
There are 3 stages of Law of Variable Proportions:
(i) Increasing Returns: In this stage, TP increases at increasing rate and later at the diminishing rate. AP
increases and reaches at its maximum.
MP initially increases then starts decreasing but continues to remain above AP
(ii) Diminishing Return: TP increases at a diminishing rate till it reaches at maximum point and then
becomes constant. AP continues to fall. MP decreases and finally becomes zero (0).
(iii) Negative Returns: TP begins to fall, AP continues to fall but remains positive. MP becomes negative.
Causes of stages of law of variable proportions or Returns to a factor:
(i) Increasing Return to a Factor:
(a) Fuller utilisation of fixed factor
(b) Specialisation of labour
(ii) Diminishing Return to a Factor
(a) Imperfect factor substitutability
(b) Disturbing the optimum proportion
(iii) Negative Returns to a Factor:
(a) Overcrowding
(b) Management problems

1 MARK
QUESTIONS


A. FILL IN THE BLANKS
1. Functional relationship between inputs and output is known as _______
2._______ and _______ are examples of fixed factors.
3. _______and_______ are examples of variable factors.
4. In _______ period all factors are variable.
5. In short period, law of _______ operates.
6. In long period, law of _______ operates.

, 7. Total product is_______ x units of variable factor.
8. Marginal product is _______
9. In law of variable proportion, the units of variable factor are assumed to be_______
10. When MP increases, TP increases at _______rate.
11. When MP falls, TP increases at _______
12. When MP becomes negative, TP _______
13. When marginal product is greater than average product, average product _______
14. When marginal product is equal to average product, average product is _______
15 _______is the slope of TP curve.
16. Two main causes of increasing returns to a factor are_______and _______
17. Both MP and AP are _______ shaped curve.
18. Two main causes of negative returns to a factor are _______ and _______
19. Shape of AP curve is _______
20. When a variable factor is combined with fixed factors, MP falls, it is known as _______
21. Fixed factors of production _______ during short run production.
22. Variable factor changes with _______ in short run production.
23. The point where TP starts increasing at diminishing rate is known as _______



ANSWERS

1. Production function 2. Land, Capital 3. Labour, Raw material 4. Long
5. Variable proportions, 6. Returns to a scale 7. AP 8. TP - TPn-1
returns to a factor
9. Identical 10. Increasing 11. Diminishing rate 12. Falls
13. Rises 14. Constant 15. Inverted S 16. Optimum use of
fixed factors,
specialisation
17. Inverted U 18. Over crowding, 19. Inverted U 20. Diminishing
Management returns
problems
21. Remain constant 22. Change in output 23. Point of inflexion.