THEORY OF PRODUCTION

 

 

•    •    MICRO ECONOMICS

THEORY OF PRODUCTION/SHORT RUN PRODUCTION FUNCTION/LONG RUN PRODUCTION FUNCTION

•    BY DR. SHASHI AGGARWAL

•    TIME PERIOD

1.       SHORT RUN IS DEFINED AS THAT PERIOD OF TIME IN WHICH ONE OR MORE FACTORS OF PRODUCTION OR INPUTS ARE FIXED AND OTHER ARE VARIABLE

2.       IN SHORT RUN THERE ARE BOTH VARIABLE INPUTS AND FIXED INPUTS

3.       IF PRODUCER WANTS TO EXPAND OUTPUT HE CAN DO SO BY USING MORE RAW MATERIALS AND HOURS OF LABOUR SERVICE WITH THE EXISTING PLANT AND MACHINERY AND VICE VERSA

4.       IN THE SHORT RUN PRODUCTION FUNCTION (TECHNOLOGICAL RELATION BETWEEN THE INPUTS AND OUTPUTS DESCRIBED THE RESTRICTED CHOICE OPEN TO FIRM SINCE SOME OF THE FACTORS ARE FIXED AND SOME ARE VARIABLE.

5.       IN THE SHORT RUN IT IS POSSIBLE TO INCREASE THE QUANTITIES OF ONE INPUT WHILE KEEPING THE QUANTITIES OF OTHER INPUTS CONSTANT IN ORDER TO HAVE MORE UNITS OF OUTPUT. IT IS KNOWN AS LAW OF VARIABLE PROPORTION WHEN A PRODUCER BRINGS CHANGES IN HIS PRODUCTION BY CHANGING ONLY ONE FACTOR OF PRODUCTION AS RESULT THERE IS CHANGE IN THE PROPORTIONS OF COMBINATION OF FACTORS OF PRODUCTION THEN THIS PROPORTIONAL RELATIONSHIP BETWEEN OUTPUT AND INPUTS IS REFERRED TO LAW OF RETURN TO A FACTOR

•    LONG PERIOD

1.       LONG PERIOD IS DEFINED AS THAT PERIOD OF TIME IN WHICH ALL FACTOR OF INPUTS ARE VARIABLE

2.       LONG PERIOD REFERS TO THAT PERIOD OF TIME IN WHICH THE QUANITITY OF ALL FACTORS CAN BE INCREASED OR DECREASED

3.       LONG PERIOD IS ASSCCIATED WITH THE CHANGES IN THE SCALE OF PRODUCTION BUT THE TECHNOLOGY OF PRODUCTION IS ASSUMED TO BE CONSTANT

•    CONCEPTS

1.       TOTAL PRODUCT: - IS THE OVERALL QUANTITY OF OUTPUT THAT A FIRM PRODUCES.

2.       AVERAGE PRODUCT: - IS DEFINED AS THE AVERAGE PRODUCT PRODUCED BY EVERY WORKER. AP =TOTAL PRODUCT/VARIABLE INPUTS. IT IS THE QUANTITY OF TOTAL OUTPUT PRODUCED PER UNIT OF VARIABLE INPUT, HOLDING ALL OTHER INPUTS FIXED.

3.       MARGINAL PRODUCT OF AN INPUT ( FACTORS OF PRODUCTION) IS THE CHANGE IN OUTPUT RESULTING FROM EMPLOYING ONE MORE UNIT OF A PARTICULAR INPUT.MP =TP_N-TP_N-1

 

 •    PRODUCTION FUNCTION

•    RETURN TO FACTOR OR PRODUCTION WITH ONE VARIABLE INPUT

1.       A PRODUCER MAY AFFECT A CHANGS IN HIS PRODUCTION BY CHANGING ONLY THE VARIABLE FACTOR, OTHER FACTORS AND TECHNOLOGY REMAINING CONSTANT.

2.       THE PROPORTIONAL RELATIONSHIP BETWEEN PRODUCTION AND VARIABLE FACTORS OF PRODUCTION IS TERMED AS RETURN TO FACTOR

•    RETURN TO FACTOR SHOWS THESE THREE PHASES:

1.       INCREASING RETURN TO A FACTOR:-INITIALLY TOTAL PRODUCTION RISES AT INCREASING RATE

2.       CONSTANT RETURNS TO A FACTOR:-RISES AT CONSTANT RATE

3.       DIMINISHING RETURN TO FACTOR:-TP INCREASES AT DIMINISHING RATE

•    HOW TO WRITE THE QUESTION IN THE QUESTION PAPER

•    DISCUSS THE LAW OF VARIABLE PROPORTION?

•    ANSWER STEPS:-

1.       MEANING OF SHORT RUN

2.       GENERAL MEANING AND DEFINITION OF THE LAW OF VARIABLE PROPORTION

3.       ASSUMPTIONS

4.       EXPLANATION IN TABULAR FORM

5.       EXPLANATION OF THE GRAPH

6.       RATIONAL DECISION

7.       CAUSES BRIEFLY

 

•    LAW OF VARIABLE PROPORTIONS

•    IN SHORT PERIOD, WHEN ONE INPUT IS VARIABLE AND ALL OTHER INPUTS ARE FIXED, THE FIRM’S PRODUCTION FUNCTION EXHIBITS THE LAW OF VARIABLE PROPORTIONS. HERE THE PROPORTION BETWEEN FIXED AND VARIABLE FACTORS IS CHANGED AND THE LAW OF VARIABLE PROPORTION SET IN.

1.       THE LAW STATES THAT AS THE QUANTITY OF A VARIABLE FACTOR IS INCREASED BY EQUAL DOSES ,

2.       KEEPING THE QUANTITIES OF OTHER FACTORS CONSTANT

3.       THE TOTAL PRODUCTION AT FIRST INCREASE MORE THAN PROPORTIONATELY,

4.       THEN EQUI PROPORTIONATELY AND FINALLY LESS THAN PROPORTIONATELY.

•    DEFINITION

•    LEFTWITCH ,” THE LAW OF VARIABLE PROPORTIONS STATES THAT IF THE INPUTS OF ONE RESOURCE IS INCREASED BY EQUAL INCREMENTS PER UNIT OF TIME, WHILE THE OTHER INPUTS OF OTHER RESOURCES ARE HELD CONSTANT, TOTAL OUTPUT WILL INCREASE, BUT BEYOND SOME POINT ,THE RESULTING OUTPUT INCREASES WILL BECOME SMALLER AND SMALLER.

CLAVO AND WAUGH,” THE LAW OF VARIABLE PROPORTION STATES THAT IF A VARIABLE QUANTITY OF ONE RESOURCE IS APPLIED TO A FIXED AMOUNT OF OTHER INPUTS, OUTPUT PER UNIT OF VARIABLE INPUT WILL INCREASE BUT BEYOND SOME POINT THE RESULTING INCREASE WILL BE LESS AND LESS AND WITH TOTAL OUTPUT REACHING A MAXIMUM BEFORE IT FINALLY BEGINS TO DECLINE

•    ASSUMPTIONS

1.       ONE OF THE FACTORS IS VARIABLE WHILE ALL OTHER FACTORS ARE FIXED.

2.       ALL UNITS OF THE VARIABLE FACTORS ARE HOMOGENEOUS

3.       LEVEL OF TECHNOLOGY AND METHODS OF PRODUCTION ARE CONSTANT.

4.       IT IS A SHORT PERIOD OPERATION

•    EXPLANATION

•    EXPLANATION

1.       FIRST STAGE: - TOTAL PRODUCT INCREASES AT INCREASING RATE. MP AND AP INCREASE IN THE BEGINNING STAGE, REACH MAXIMUM AND THEN START DECLINING. AND WHEN AP IS MAXIMUM THEN IT IS EQUAL TO MP. STAGE RELATES TO INCREASING AVERAGE RETURNS.

2.       SECOND STAGE :- TP INCREASES AT DECREASING RATE AND END OF STAGE IT BECOMES CONSTANT AND AP AND MP ALSO DECREASE AND MP AT THE END OF THE STAGE IT BECOMES ZERO

3.       THIRD STAGE: - TP STARTS DECLINING AND MP BECOMES NEGATIVE AND AP ALSO FALLS.

•    DIAGRAM

            

                                            

•           

 

•    EXPLANATION

•    DURING THE FIRST STAGE, THE MARGINAL OUTPUT RISES AND ULTIMATELY BEGIN TO FAIL. THE AVERAGE PRODUCT RISE AND BECOMES CONSTANT IN THE END OF THE FIRST STAGE AND BECOMES EQUAL TO MP AND SECOND STAGE MP BECOMES ZERO AND AP STARTS FALLING AND IN THIRD STAGE MP BECOMES NEGATIVE AND TP STARTS DECREASING AND AP ALSO FALLS. THIRD STAGE IS KNOWN AS “ECONOMIC ABSURDITY OR ECONOMIC NONSENSE. A RATIONAL PRODUCER WILL PRODUCE UPTO SECOND STAGE AND IT WILL NEVER PRODUCE IN THIRD STAGE.

•    STAGE OF  RATIONAL DECISION

•    IN ORDER TO ACHIEVE  MAXIMUM PROFITS,THE RATIONAL DECISION OF THE PURELY COMPETITIVE FIRM WILL BE TO OPERATE IN STAGE II
•    FIRM WILL OPERATE NETHER IN STAGE I NOR IN STAGE III

•    ACTUAL VOLUME OF PRODUCTION IN STAGE II WILL DEPEND ON THE PRICES OF INPUT AND OUTPUT

•    CAUSES

1.       INDIVISIBILITY OF FACTORS

2.       DIVISION OF LABOUR

3.       IMPERFECT SUBSTITUTE

4.       CHANGE IN FACTOR RATIO

•    POSTPONEMENT OF THE LAW

1.       BY IMPROVING TECHNOLOGY

2.       WHEN THE FACTORS OF PRODUCTION ARE PERFECTLY SUBSTITUTE

•    UNIVERSALITY OF THE LAW

•    IN THE WORDS OF MARSHALL,” THE PART PLAYED BY NATURE CONFORMS TO DIMINISHING RETURNS WHILE THE PART WHICH MAN PLAYS CONFORM TO INCREASING RETURNS.

 

• PHASES OF LAW OF VARIABLE PROPORTIONS
• INCREASING RETURNS
•  CONSTANT RETUNRS
• DIMINISHING RETURNS
• LAW OF INCREASING RETURNS-PHASES OF LAW OF VARIABLE PROPORTIONS
• MEANING
• LAW OF INCREASING RETURNS STATES THAT MORE OF A VARIABLE FACTOR IS EMPLOYED, TOTAL PRODUCTION INCREASES AT A HIGHER RATE THAN RATE OF INCREASE IN THE EMPLOYMENT OF A VARIABLE FACTOR. THIS LAW WAS GIVEN BY 17 TH CENTURY ECONOMIST ANTONIA SEERA.
• THE LAW WHEN EXPLAINED IN TERMS OF COSTS IS CALLED THE LAW OF DIMINISHING COSTS.
• BENHAM,” AS THE PROPORTIONS OF ONE FACTOR IN A COMBINATION OF FACTORS IS INCREASED UPTO A POINT THE MARGINAL PRODUCTIVITY OF THE FACTOR WILL INCREASE.
• MEANING
• MARSHALL: AN INCREASE OF LABOUR AND CAPITAL LEADS GENERALLY IMPROVED ORGANIZATION WHICH INCREASE THE EFFICIENCY OF THE WORK OF LABOUR AND CAPITAL
• THERFORE IN THOSE INDUSTRIES WHICH ARE NOT ENGAGED IN RAISING RAW PRODUCE AN INCREASE IN LABOUR AND CAPITAL GENERALLY GIVES A RETURN INCREASED MORE THAN IN PROPORTION
• 1. TENDENCY  TO INCREASING RETURN ARISES ON ACCOUNT OF IMPROVD ORGANIZATION
• OPERATES IN MANUFACTURING NOT IN EXTRACTIVE INDUSTRIES SUCH AS AGRICULTURE,MINING,FORESTRY AND
• BUT MODERN ECONOMISTS DO NOT AGREE WITH MARSHALL
• ASSUMPTIONS

1. SCOPE OF IMPROVEMENT IN THE TECHNIQUE OF PRODUCTION AND ORGANIZATION OF PRODUCTION
2. AT LEAST ONE OF FACTOR IS INDIVISIBLE
3. SOME FACTORS OF PRODUCTION ARE SUPPOSED TO BE DIVISIBLE

• EXPLANATION OF THE LAW
• ( INCREASING RETURNS)
• 
  
  
  
• EXPLANATION
• AS WE CLEARLY SEE FROM THIS TABLE AS UNITS OF VARIABLE FACTORS GO ON INCREASING TOTAL PRODUCT INCREASES AT INCREASING RATE AND MARGINAL PRODUCT GOES ON INCREASING.
• EXPLANATION ( DIMINISHING COSTS)
• 
  
  
  
• CAUSES

1. INDIVISIBILITY OF FACTORS
2. SPECIALIZATION
3. FIXED FACTORS
4. ECONOMIES OF LARGE SCALE PRODUCTIONS

• APPLICATION TO INDUSTRIES

1. USE OF MACHINERY
2. LESS INFLUENCE OF NATURE
3. DIVISION OF LABOUR
4. ECONOMIES OF SCALE

• THE LAW OF CONSTANT RETURNS
•  
• MEANING
• AS MORE AND MORE UNITS OF THE VARIABLE FACTOR ARE APPLIED WITH THE FIXED FACTOR MARGINAL PRODUCT TENDS TO REMAIN CONSTANT. TOTAL OUTPUT INCREASES AT CONSTANT RATE.
• DR. MARSHALL,” IF THE ACTIONS OF THE LAW OF INCREASING AND DIMINISHING ARE BALANCED WE HAVE LAW OF CONSTANT RETURNS.
• EXPLANATION OF THE LAW
• 
  
  
  
• EXPLANATION
• 
  
  
  
  
  
  
  
• THE LAW OF DIMINISHING RETURNS
• MEANING
• WHEN A FIXED AMOUNT OF ANY FACTOR OF PRODUCTION, SUCCESSIVE UNITS OF ANY VARIABLE FACTOR OF PRODUCTION ARE EMPLOYED THEN TOTAL OUTPUT WILL INCREASE BUT AT DIMINISHING RATE.
• ACCORDING TO BOULDING “ AS WE INCREASE THE QUANTITY OF ANY ONE INPUT WHICH IS COMBINED WITH FIXED QUANTITY OF OTHER INPUTS, THE MARGINAL PHYSICAL PRODUCTIVITY OF THE VARIABLE INPUTS MUST EVENTUALLY DECLINES.
• ASSUMPTIONS
• SHORT RUN
• FIXED AND VARIABLE FACTORS
• HOMOGENEOUS
• CHANGE IN THE FACTOR PROPORTIONS
• CONSTANT TECHNOLOGY
• NO CHANGE IN PRICE
• EXPLANATION
• 
  
  
  
• EXPLANATION
• AS WE SEE FROM THIS TABLE AS MORE UNITS OF LABOUR ARE APPLIED THE TOTAL OUTPUT INCREASES AT A DIMINISHING RATE AND MARGINAL PRODUCT ALSO GOES ON DIMINISHING.
• INCREASING COSTS
• 
  
  
  
• CAUSES

1. FIXED FACTORS OF PRODUCTION
2. BEYOND THE OPTIMUM CAPACITY
3. IMPERFECT SUBSTITUTES

• APPLICATION
• APPLICATION TO AGRICULTURE: IN AGRICULTURE LABOUR AND CAPITAL CAN BE INCREASED TO THE DESIRED EXTENT BECAUSE THEY ARE VARIABLE FACTORS. BUT NOT THE LAND WHICH IS FIXED FACTOR

 

• APPLICATION TO EXTRACTIVE INDUSTRIES: THOSE INDUSTRIES IN WHICH THE ROLE OF MAN IS MARGINAL AND WHILE THE ROLE OF THE NATURE IS DOMINANT.
• MINES AND QUARRIES: IN ORDER TO EXTRACT MORE AND MORE MINERALS ONE HAS TO GO DEEP. EXPENSE ON LIGHTING, PUMPING WILL INCREASE.
• FOREST WEALTH: THE LAW ALSO APPLIES TO FOREST WEALTH. IN ORDER TO GET MORE WOODS,PENETRATION INTO THE FOREST REQUIRES ADDITIONAL EXPENSES
• APPLICATION
• BUILDINGS: LAW ALSO APPLIES TO MULTI-STOREY BUILDING. HIGHER THE BUILDING. HIGHER THE BUILDING LARGER THE PROPORTIONAL EXPENDITURE. RENT OF UPPER STOREYS GOES ON DIMINISHING.
• POTTERY: EVEN POTTERY AND BRICK ARE SUBJECT TO THE LAW. EARTHEN WARES AND BRICKS ARE MADE OUT OF CLAY WHICH IS TO BE DUG OUT. MORE DEEPER THE MORE EXPENSES
• FISHERIES : TO CATCH MORE FISH ONE HAS TO GO MORE DEEP INTO WATER
•  
• APPLICATION TO INDUSTRIES: IN MANUFACTURING INDUSTRIES THE LABOUR AND CAPITAL PLAY GREATER ROLE THAN LAND DURING THE SHORT PERIOD. IN THE SHORT PERIOD THE CAPITAL IS FIXED AND MORE AND MORE LABOUR IS EMPLOYED ON THE FIXED FACTORS THE MP OF LABOUR FALLS
• ACCORDING TO WICKSTEED : THE LAW OF DIMINISHING RETURN IS LAW OF LIFE AND CAN BE APPLICABLE ANYWHERE
• BUT IT APPLIES FASTER TO AGRICULTURE.
• APPLICATION OF THIS LAW TO SPECIALLY AGRICULTURE

1. NATURAL FACTORS: NATURE PLAYS DOMINAT ROLE IN AGRICULTURE. NATURAL FACTORS GREATLY INFLUENCE AGRICULTURE. UNCERTAINTY IS THERE.
2. SEASONAL INDUSTRY : AGRICULTURE IS SEASONAL
3. DIFFICULTY IN SUPERVISION
4. DIFFERENCE IN FERTILITY
5. LESS CHANCES OF DIVISION OF LABOUR
6. LESS USE OF MACHINES
7. LAND IS LIMITED

• IMPORTANCE OF THE LAW

1. BASIS OF MALTHUSIAN THEORY OF POPULATION
2. BASIS OF THEORY OF RENT
3. MARGINAL PRODUCTIVITY THEORY OF DISTRIBUTION
4. BASIS OF INVENTION
5. OPTIMUM PRODUCTION
6. BASIS OF MIGRATION OF POPULATION
7. EXPLANATION OF DISGUISED UNEMPLOYMENT

• IMPORTANCE OF THE LAW
• BASIS OF MALTHUSIAN THEORY OF POPULATION: PRODUCTION OF FOOD GRAINS LAG BEHIND INCREAS IN POPULATION.
• BASIS OF THEORY OF RENT : FIRST DOSE OF LABOUR AND CAPITAL YIELD MORE RETURNS THAN SECOND DOSE
• MARGINAL PRODUCTIVITY THEORY OF DISTRIBUTION: IS ALSO BASED ON THE LAW. AS MORE AND MORE UNITS OF  FACTORS ARE HIRED THEN MP GOES ON FALLING
• BASIS OF INVENTION
• OPTIMUM PRODUCTION
• BASIS OF MIGRATION OF POPULATION
• EXPLANATION OF DISGUISED UNEMPLOYMENT
• OPTIMUM PRODUCTION: WITH THE HELP OF THIS LAW A PRODUCER CAN DECIDE ABOUT OPTIMUM OUTPUT. EQUILIBRIUM IS WHERE MC=MR
• EFFECT ON ECONOMIC DEVELOPMENT :OPERATION OF THE LAW RESPONSIBLE FOR  THE STATIONARY STATE

 

 

 

• RETURNS TO SCALE
• DR SHASHI AGGARWAL
• LONG PERIOD

1.  IT IS POSSIBLE FOR A FIRM TO CHANGE ALL INPUTS UP OR DOWN ITS SCALE
2. KNOWN AS RETURNS TO SCALE
3. WHEN A PRODUCER CHANGES ALL FACTORS OF PRODUCTION IN THE SAME PROPORTIONS THE PROPORTIONAL RELATIONSHIP IS KNOWN AS RETURNS TO SCALE
4. IN ORDER TO INCREASE THE OUTPUT OF COMMODITY EITHER THE AMOUNT OF THE FACTORS OF PRODUCTION IS TO BE INCREASED OR TECHNIQUE TO BE IMPORVED

 

• LONG  RUN PRODUCTION FUNCTION

 

 

• THE LAW OF RETURNS OF SCALE
• LONG RUN CONCEPT. RETURN TO SCALE EXPLAINS THE BEHAVIOUR OF OUTPUT WHEN THE QUANTITY OF ALL THE FACTORS ARE RAISED SIMULTANEOUSLY IN A GIVEN PROPORTION.
• IN ORDER TO INCREASE THE SCALE OF PRODUCTION UNITS OF VARIOUS FACTORS OF PRODUCTION MUST BE RAISED IN GIVEN PROPORTION
• KOYTOSYIANNIS,” THE TERM RETURNS TO SCALE REFERS TO THE CHANGE IN OUTPUT AS ALL FACTORS CHANGE IN THE SAME PROPORTIONS. “

 

• THE LAW OF RETURNS OF SCALE

·         IN THE LONG RUN OUTPUT CAN BE INCREASING ALL FACTORS IN THE SAME PROPORTION OR DIFFERENT PROPORTION

·         LAW OF RETURN TO SCALE REFERS To INCREASE IN OUTPUT AS A RESULT OF INCREASE IN ALL FACTORS IN THE SAME PROPORTIONS

·         LEIFBHAFASKY: RETURNS TO SCALE RELATES TO THE BEHAVIOUR OF TOTAL OUTPUT AS ALL INPUTS VARIED AND IS A LONG RUN CONCEPT.

• EXPLANATION
• LAW OF RETURNS TO SCALE REFERS TO INCREASE IN OUTPUT AS A RESULT OF INCREASE IN ALL THE FACTORS IN THE SAME PROPORTIONS. SUCH AN INCREASE IN OUTPUT IS CALLED RETURNS TO SCALE.
• Q = f( L,K)
• IF BOTH THE FACTORS OF PRODUCTION I.E. LABOUR AND CAPITAL ARE INCREASED IN SAME PROPORTIONS.
• Q =f(mL,m K)
• IF   Q₁ INCREASE MORE THAN PROPORTION INCREASE IN FACTOR OF PRODUCTION Q₁ / Q  >m THEN IT IS INCREASING RETURN TO SCALE
•  

 

• EXPLANATION
• IF   Q₁ INCREASE IN THE SAME PROPORTION INCREASE IN FACTOR OF PRODUCTION Q₁ / Q  =m THEN IT IS CONSTANT  RETURN TO SCALE

 

• IF   Q₁ INCREASE LESS THAN PROPORTIONAL INCREASE IN FACTOR OF PRODUCTION Q₁ / Q  <m
  
  
  
  THEN IT IS DIMINISHING RETURN TO SCALE
•  

 

• EXPLANATION
• 
• STAGES OF RETURNS TO SCALE
• INCREASING RETURNS TO SCALE: - WHEN A GIVEN PERCENTAGE INCREASE IN ALL FACTORS INPUTS CAUSES PROPORTIONATELY GRATER INCREASE IN OUTPUT. IF 10% INCREASE IN ALL INPUTS AND THERE IS INCREASE IN 20% IN OUTPUT. IT IS CALLED INCREASE IN INCREASING RETURNS TO SCALE

 

• DIAGRAM
•  
  
  
  
•               

 

 

 

 

• MAIN CAUSE OF INCREASING RETURN TO SCALE
• WHEN SCALE OF OPERATION IS INCREASED THEN DUE TO INDIVISIBILITY OF FACTORS SUCH AS LABOUR ,TOOLS,IMPLEMENTS AND MACHINES AND DIVISION OF LABOUR AND SPECIALIZATION AND MANY TYPES OF ECONOMIES ARE AVAILABLE
• SO PROPORTIONAL INCREASE IN THE RETURN IS MORE THAN INCREASE IN FACTORS OF PRODUCTION
• FIRMS ALSO ENJOY INCREASING RETURNS TO SCALE DUE TO EXTERNAL ECONOMIES. WHEN A LARGE NUMBER OF FIRMS ARE CONCENTRATED AT ONE PLACE SKILLED LABOUR,CREDIT AND TRASNPORT AVIALABLE
• CONSTANT RETURN TO SCALE
• CONSTANT RETURNS TO SCALE: - WHEN A GIVEN PERCENTAGE INCREASE IN ALL FACTORS INPUTS CAUSES SAME INCREASE IN OUTPUT. IF 10% INCREASE IN ALL INPUTS AND THERE IS INCREASE IN 10% IN OUTPUT. IT IS CALLED  CONSTANT RETURNS TO SCALE
• CONSTANT RETURN TO SCALE
•   

 

·          

 

 

• CAUSES OF RETURN TO SCALE
• WHEN AFTER REACHING A CERTAIN LEVEL OF PRODUCTION,ECONOMIES OF SCALE ARE COUNTER BALANCED WHICH REFLECT CONSTANT PRODUCTION
• ALSO CALLED LINEAR HOMOGENEOUS PRODUCTION FUNCTION OF FIRST DEGREE IS IMPORTANT IN EULER’S THEORUM
• THIS FUNCTION STATES : IF LABOUR AND CAPITAL  ARE INCREASED IN EQUAL PROPORTIONS THE OUTPUT WILL ALSO INCREASE IN SAME PROPORTIONS
• DIMINIHING RETURNS TO SCALE
• DIMINISHING RETURNS TO SCALE: - WHEN A GIVEN PERCENTAGE INCREASE IN ALL FACTORS INPUTS CAUSES LESS THAN PROPORTION INCREASE IN OUTPUT. IF 10% INCREASE IN ALL INPUTS AND THERE IS INCREASE IN 8% IN OUTPUT. IT IS CALLED  DIMINISHING RETURNS TO SCALE
• DIMINISHING RETURNS TO SCALE
• EXPLANATION               

 

 

 

 

 

 

• RATIO OF CHANGE IN OUTPUT IS LESS THAN RATIO OF CHANGE IN INPUTS.
• REASON

1. THE MAIN CAUSE OF ITS OPERATION IS DISECONOMIES OUTWEIGH ECONOMIES OF SCALE
2. INDIVISIBLE FACTORS BECOMES INEFFICIENT AND LESS PRODUCTIVE ,DIFFICULTY OF CONTROL AND RIGIDITIES DUE TO LARGE MANAGEMENT AND HIGHER COST OF LABOUR AND MORE PRICE OF RAW MATERIALS

• DIFFERENCE
• RETURNS TO SCALE

1. OPERATES IN THE LONG RUN
2. CHANGE IN ALL FACTORS ON OUTPUT
3. TECHNOLOGY MAY CHANGE

• RETURNS TO FACTOR

1. SHORT RUN PHENOMENON
2. EFFECT OF CHANGE IN THE UNITS OF ONE FACTOR ON OUTPUT
3. TECHNOLOGY REMAINS TO CONSTANT

•