Page 112 - DECO405_MANAGERIAL_ECONOMICS

Unit 7: Laws of Production

Notes
Figure 7.1

7.1.1 Three Stages of Production

Diminishing returns to a factor can be graphically understood with the help of total and marginal
product curves. In Figure 7.1, the TPP curve rises first to an increasing rate in stage I and later at
a diminishing rate in stage II. At stage II, the TPP remains constant. Thus, the total output
increases more than proportionately until X units of labour are employed; between X units and
Y units of labour used, the total output rises with every additional unit of labour but this
increase is less than proportionate. If labour units increase beyond level Y, the total output
eventually starts decreasing. Correspondingly when TPP is rising at an increasing rate, MPP and
APP curves are rising; and when total product is rising at a diminishing rate, the MPP and APP
curves are declining. At Y, where TPP becomes constant, the MPP becomes zero, and additional
labour beyond Y makes MPP negative. These three phases of TPP curve are called the three
stages of production and are summarized in Table 7.2.
No firm will choose to operate either in Stage I or Stage III. In Stage I the marginal physical
product is rising, i.e., each additional unit of the variable factor is contributing to output more
than the earlier units of the factor; it is therefore profitable for the firm to keep on increasing the
use of labour. In Stage III, marginal contribution to output of each additional unit of labour is
negative; it is therefore, not advisable to use any additional labour. Even if cost of labour used
is zero, it is still unprofitable to move into Stage III. Thus, Stage II is the only important range for
a 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.

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