Page 110 - DECO405_MANAGERIAL_ECONOMICS

Ashwani Panesar, Lovely Professional University
Unit 7: Laws of Production

Unit 7: Laws of Production Notes

CONTENTS
Objectives
Introduction
7.1 Law of Diminishing Returns to Factor (Law of Variable Proportions)

7.1.1 Three Stages of Production
7.1.2 Optimal use of Variable Input
7.2 Returns to Scale (Law of Returns to Scale)

7.3 Summary
7.4 Keywords
7.5 Self Assessment
7.6 Review Questions
7.7 Further Readings

Objectives

After studying this unit, you will be able to:
Discuss law of diminishing returns to factor and returns to scale
Explain the law of returns of scale

Introduction

In this unit, we will discuss the laws of production. In the short run, the law of diminishing
returns states that as we add more units of a variable input (i.e. labour or raw materials) to fixed
amounts of land and capital, the change in total output will at first rise and then fall. Diminishing
returns to labour occurs when marginal product of labour starts to fall. This means that total
output will still be rising - but increasing at a decreasing rate as more workers are employed. In
the long run, all factors of production are variable. How the output of a business responds to a
change in factor inputs is called returns to scale.

7.1 Law of Diminishing Returns to Factor (Law of Variable
Proportions)

If all inputs of a firm are fixed and only the amount of labour services differs, then any decrease
or increase in output is achieved with the help of changes in the amount of labour services used.
When the firm changes the amount of labour services only, it changes the proportion between
the fixed input and the variable input. As the firm keeps on changing this proportion by changing
the amount of labour, it experiences the law of variable proportion or diminishing marginal
returns. This law states that,
As more and more of the factor input is employed, all other input quantities remaining constant,
a point will finally be reached where additional quantities of varying input will produce
diminishing marginal contributions to total product.

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