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Unit 8: Laws of Production

zero, it is still unprofitable to move into Stage III. Thus, Stage II is the only important range for a Notes

rational firm in a competitive situation. However, the exact number of labour units hired can be
found only when the corresponding data on wage rates is available.
Table 8.2: Stages of Production
Total Physical Prod- Marginal Physi- Average Physical Additional
uct cal Product Product Information

Stage I
Increases at an in- Increases and Increases (but Fixed inputs grossly under uti-
creasing rate reaches its maxi- slower than MPP) lised, specialisation and team
mum work cause APP to increase
when additional input is used

Stage II
Increases at a di- Starts diminish- Starts diminishing Specialisation and teamwork
minishing rate and ing and becomes continue and result in greater
becomes maximum equal to zero output when additional input is
used, fixed input is being prop-

erly utilised
Stage III
Reaches its maximum, Keeps on declin- continues to Fixed inputs capacity is reached,
becomes constant and ing and becomes diminish but must additional input causes output
then starts declining negative always be greater to fall
than zero

8.1.2 Optimal use of Variable Input

It is important for the firm to decide how much labour it should use in order to maximize profi ts.

The firm should employ an additional unit of labour as long as the extra revenue generated from
the sale of the output produced exceeds the extra cost of hiring the unit of labour, i.e., until the
extra revenue equals the extra cost.
Thus, if an additional unit of labour generates ` 300/- in extra revenue and costs an extra ` 200/-

then it pays for the firm to hire this unit of labour as its total profit increases. This is an example
of application of the general optimization principle.
The extra revenue generated by the use of an additional unit of labour is called the Marginal
Revenue Product of Labour (MRP ). This equals the Marginal Product of Labour (MP ) times the
L L
Marginal Revenue (MR) from the sale of the extra output produced. Thus,
MRP = (MP ) (MR)
L L
The extra cost of hiring an additional unit of labour or Marginal Resource Cost of Labour (MRC )
L

is equal to the increase in the total cost to the firm resulting from hiring the additional unit of
labour. Thus,
Δ TC
MRC =
Δ L
L

A firm should continue to hire labour as long as MRP > MRC and until
L L
MRP = MRC
L L
This is applicable to any variable input and not just labour.

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