Theory Of Production and Law of variable proportions


• In  General,  Production  means,     "Any Activity of Making Something Material."

• In  Economics,  Production  means,  "Any Economic  Activity  which  is  directed  to the Satisfaction of the Wants of the People.

• Production means "Creation or Addition of Utility". 


  1. Form Utility
  2. Place Utility
  3. Time Utility

Form Utility

Changing  the  Form  of  Natural  Resources  i.e. Converting   the   Raw   Material   into   items Possessing Utility.

For  Example,  Changing  the  form  of  a  Log  of Wood into a Table or Changing the form of Iron into a Machine.

Place Utility

Changing the Place of Resources from the Place where they are of little or no use to another place where they are of Greater use. Extraction from Earth
• Removal  of  Coal  ,  Gold  etc from Mines & Supplying them to Markets.

Transferring Goods from Where they give little or no Satisfaction to places where utility is more

Time Utility

Making Available Materials at times when they are not Normally Available.
For Example, Harvested Food Grains are Stored for use till next Harvest. Canning of Seasonal  Fruits  is  undertaken  to  make them available during off Season.



Factors of Production

  1. Natural Resources
    1. • Land
  2. Human Resources
    1. • Labour
    2. • Capital
    3. • Entrepreneur


Land in Economics does not mean Soil or Earth’s Surface alone  but  refers  to  all  Free Gifts of Nature which would include Natural Resources, Fertility of Soil, Water, Air, etc.

Characteristics of Land

• Land is a Free Gift of Nature.

• Land is Strictly Limited in Quantity.

• Land   cannot   be   Shifted   from   one place to another place.

• Properties     of     Land     cannot     be Destroyed.

• Land does not Yield any Result unless Human Efforts are employed


• Labour   is   referred   to   as   "Mental   or Physical Exertion directed to Produce Goods or Services ".

• Work  done  for  the  Sake  of  Pleasure  or Love does not represent Labour in Economics. Eg. If a Person Sings before his Friends, it will not be Labour as it is done for the Sake of Pleasure.

Characteristics of Labour

• Directly     connected     with     Human Efforts.

• Highly ‘Perishable’

– A Labourer cannot Store his Labour.

• Inseparable from Labourer

• Labour Power differs from Labourer to Labourer

• All Labour is not productive


• Capital  is  that  part  of  Wealth  of  an Individual or Community which is used for further Production of Wealth.

• It  is  a  Stock  Concept  which  yields  a Periodical Income which is a Flow Concept.

• It  is  Termed  as  "Produced  Means  of Production" or "Man Made Instruments of Production" e.g. Factories, Dams, etc.

Capital Formation

• It means a Sustained Increase in the Stock of Real Capital in a Country.

• Also Known as Investment.

• Stages of Capital Formation:

– Savings

– Mobilization of Savings

– Investment


• Entrepreneur     mobilizes     all     the Factors of Production i.e. Land, Labour & Capital, Combines in the Right Proportion,  Initiates  the Process of Production & bears Risk involved in it.

• Also known as "The Organiser"; "The Manager"; "The Risk Taker".

Functions of Entrepreneur

• Initiating   a   Business   Enterprise   & Resource Co-Ordination

• Risk Bearing or Uncertainty Bearing

– Financial Risk

– Technological Risk

• Innovations

Production Function

• It states the relationship between Inputs & Output.

• It       defines       the       Minimum Quantities of various Inputs that are required to Yield a given Quantity of Output under a given State of Technology.

Short Period

• Capital is a Fixed Factor
• Law of Variable Proportions is applied

Long Period

•  All Variable Factors
• Law of Returns to Scale is applied


Basic Concepts to Law of Variable Proportions


  1. Total Product
  2. Average Product
  3. Marginal Product


Total Product (TP)

• Total    Product    is    the    Total    Output resulting from the efforts of all the Factors  of  Production  combined together at any Time.

• One Factor kept Constant, Total Product will vary with the Quantity used of the Variable Factor.

• Total  Product  rises  as  more  &  more Units of

Average Product (AP)

• Average Product is the Total Product per unit of the Variable Factor. i.e.

AP =         Total Product         
              Units of Variable Factor

Marginal Product (MP)

• Marginal  Product  is  the  Change  in Total Product per unit Change in the Quantity of Variable Factor. i.e., Marginal Product if the Addition made to the Total Production by an Additional Unit of Output.

MP = TUn – TUn-1


Relationship Between AP & MP

• Derived from Total Product

• MP > AP, when AP rises as a result of an Increase in Quantity of Variable Input

• MP = AP, when AP is Maximum i.e. MP curve cuts the AP curve at its Maximum

• MP <   AP, when AP falls as a result of a Decrease in Quantity of Variable Input

Law of Variable Proportions

• It refers to Input-Output relationship, when the Output is Increased by varying the Quantity of one Input.

• Law Operates in Short-Run when all the Factors of  Production cannot  be  Increased  or Decreased.

• Law states that "As we Increase the Quantity of One Input which is combined with other Fixed Inputs, the Marginal Physical Productivity of the Variable Input must eventually Decline.

•  The Law of Variable Proportions states that if the Input of one Resource is Increased by equal Increments per unit of Time while the Inputs of other resources are held Constant, Total Output will Increase, but beyond some point   the   resulting   Output   Increased   will   become Smaller & Smaller. By: Leftwitch

•  The Law states that an Increase in some Input relative to other Fixed Input will, in a given State of Technology, cause Total Output to  Increase; but after a  point the extra Output resulting from the same addition of extra Inputs is likely to become Less & Less. By: Samuleson

Assumptions to the Law

• One of the Factor is Variable while all other Factors are Fixed.

• All  Units  of  the  Variable  Factor  are Homogenous.

• State of Technology is Constant.

• Factors of Production can be used in Different Proportions.



Stage of Operation

• A Rational Producer will not Produce in

– Stage 3 as MP of Variable Factor is Negative.

– Stage 1 as Factors of Production are Under- Utilised.

• A  Rational  Producer  will  always  Produce  in Stage 2 where both the Marginal Product & Average Product of the Variable Factors are Diminishing. At which particular Point in this Stage, a Producer will decide to Produce depends upon Prices of Factors

Causes of Applicability of the Law

• Underutilization of Fixed Factor

• Fixed Factors of Production

• Optimum Production

• Imperfect Substitute

Law of Returns to Scale

• It refers to Input-Output relationship, when the Output is Increased by varying the Quantity of All Inputs.

• Law   Operates   in   Long-Run   when   all   the Factors of Production can be Increased or Decreased.

• It  is  the  study  of  Behaviour  of  Output  in response to Change in Scale i.e. All Factors are    Increased    or    Decreased    in    Same Proportion.

Constant Returns to Scale 
• With the Increase in the Scale in some Proportion, Output Increases in Same Proportion

Increasing Returns to Scale
• With the Increase in the Scale in some Proportion, Output Increases in Greater Proportion

Decreasing Returns to Scale
• With the Increase in the Scale in some Proportion, Output Increases in Smaller Proportion

Economies of Scale of Production

• According to Stigler, "Economies of Scale is Synonym of Returns to Scale".

• When Scale of Production is Increased, up to a   Point, One gets Economies of Scale. Thereafter Diseconomies of Scale will follow.

• Increasing Returns to Scale is the result of these Economies.



Internal Economies of Scale

• When a Firm Increases its Scale of Production, it enjoys several Economies which are termed as "Internal Economies".

• According  to  Cairncross,  "Internal  Economies are those which are open to a Single Factory, or a Single Firm independently of the action of Other Firms. They result from an Increase in the Scale of Output of a Firm & cannot be achieved unless Output Increases".

Real Economies of Scale

• Real   Economies   are   those   associated   with   a Reduction in the Physical Quantity of Inputs, Raw Materials,  Various  types  of  Labour  &  Various Types of Capital.
• These are of following types:
a)   Labour Economies
b)   Technical Economies c)   Inventory Economies d)   Marketing Economies
e)   Managerial Economies
f)    Transport & Storage Economies

Labour Economies


Increase  in  Scale  of  Production  results into the following Economies of Labour:

a) Specialization
b) Time Saving
c) New Inventions
d) Automation of Production Process


• Technical Economies

These Economies influence the Size of the Firm. These result from Greater Efficiency of the Capital Goods employed by the Firm. These are of following types:

a)  Economies of Increased Dimension
b) Economies of Linked Processes
c)  Economies of Use of By-Product


• Inventory Economies

A   Large-sized   Firm   enjoys   several types of Inventory Economies such as:
a) Large Stock of Raw Materials
b) Large  Stock  of  Spare  Parts  &  Small Tools As such there is no Fear of Stoppage of Production.

• Marketing Economies

A  Large-sized  Firm  enjoys  several  types  of Marketing Economies such as:
a)  Economies on Account of Advertisement
b)  Appointment of Sole Distributors & Authorized Dealers
c)  Economies    on    account    of    Research    & Development
All  this  enables  the  Firm  to  Produce  Quality Products.

• Managerial Economies

a) Appointment  of  Efficient  &  Talented Managers.

b) Decentralization of Task With  the  Increase  in  Production,  the Management Cost goes on Falling. 

Transport & Storage Economies

a) Own Transportation System

b) Own Storage & Godown Facilities.

With this the Firm is able to Sell its Products at the Opportune Time & at Favourable Price.

Pecuniary Economies of Scale

• Pecuniary  Economies  are  Economies  realized from paying Lower Prices for the Factors used in Production & Distribution due to bulk buying by the Firm as its size Increases.

• For Example, Procurement of Raw Material at Low  Prices,  Concessional  Loans  from  Bank, Large Discounts & Commissions on Advertisement  &  Publicity  of  their  Products, etc.

External Economies of Scale

•  External Economies of Scale refers to all those Benefits & Facilities which are available to all the Firms in a given Industry.

•  In the words of Cairncross, "External Economies are those which are shared in by a number of Firms or Industries when the Scale of Production in Industry or Group of Industries  Increases.  They  are  not  Monopolized  by  a Single Firm when it grows in Size, but are conferred on it when other Firms grow Larger".
•  The following 3 are External Economies:
a)   Economies of Concentration b)   Economies of Information
c)    Economies of Disintegration

Economies of Concentration

• When   several   Firms   of   an   Industry establish themselves at one place, then they enjoy many benefits together.

• For  Example,  Availability  of  Developed means of Communication & Transport, Trained  Labour  by  Products, Development of New Inventions pertaining to that Industry, etc.

Economies of Information

• When  the  number  of  Firm  in  an Industry Increases, then it becomes possible for them to have concerted efforts & collective activities such as Publication of Scientific & Trade Journals providing sundry Information to the Firms of a given Industry.

Economies of Disintegration

• When an Industry develops, the Firms engaged in it Mutually Agree to divide the Production Process among them. Every firm Specializes in the Production of a particular item concerning that Industry.

• It is of Two Types:

– Horizontal Disintegration

– Vertical Disintegration

Diseconomies of Scale

• When a given percentage Increase in all the Factors causes less than proportionate Increase in Output after a point, is referred to as Diseconomies of Scale. i.e. Increase in Scale beyond the Optimum level, results in Diseconomies of Scale.

• It is of Two kinds:

– Internal Diseconomies

– External Diseconomies

Internal Diseconomies of Scale

• These  Diseconomies  arise  when  a given Firm Increases its Scale of Production beyond a certain Point.

• These   do   not   affect   the   entire

• These arise because of 2 reasons:
a) Unwieldy Management
b) Technical Difficulties

External Diseconomies of Scale

• These Diseconomies are suffered by all the Firms in an Industry irrespective of their Scale of output.

• For   Example,   when   many   Firms   are localized at a particular place, then it becomes  difficult  for  Means  of Transport to cope up with the additional burden of Traffic, and hence Transport Costs go up.

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