Production Theory

The Law of Variable Proportions

• It states that when total output or production of a
commodity is increased by adding units of a variable
inputs while the quantities of other inputs are held
constant, the increase in total production becomes
after some point, smaller and smaller.
• The law of variable proportion is a widely observed law
of production which takes place in the short run.
• In the short run, production can be increased by using
more of the variable factor. This law is applicable to all
sectors of an economy.
Stages Term Used TP AP MP Ref.Point
Stage I Increasing Starts from Starts from Increases From Origin
Returns to the origin, origin and reaches a to point A
the factor increases at then maximum
an increases till point and
increasing it reaches its then starts
rate and maximum falling
then point
increases at
a decreasing
rate

Stage II Diminishing Increases at Falls Falls From point

returns to a decreasing continuousl continuousl A to B
the factor rate till it y y till it is
reaches the equal to
maximum zero
point
Stage III Negative Falls Falls It is negative From point
Returns to continuousl B onwards
the factor y
 Law of variable proportions
Assumptions
1. Labour is the only variable input, capital
remaining constant
2. Labour is homogeneous-same skills and
knowledge
3. The state of technology is given
4. Input prices are given and do not change
5. Output is measured in physical units
Variable Total Average Marginal Different
Factor(Units of Product(TP) Product(AP) Product(MP) Stages
labour)

0 0 0 - STAGE I
Increasing
1 4 4 4 Returns
2 10 5 6

3 18 6 8

4 24 6 6 STAGE II
Diminishing
5 28 5.6 4 Returns
6 30 5 2

7 30 4.3 0

8 28 3.5 -2 STAGE III

Negative
Returns
 The Three Stages of Production
• The law of variable proportions can be divided
into three distinct stages.
• These three stages of the short run law of
production are graphically illustrated by the
relationship between, TP, AP and MP.
STAGE I:Stage of Increasing Returns
• This is the very first stage in which additional
units of labour are employed , the total product
increases more than proportionately, so marginal
product rises. It begins from origin and continues
to a point where MP attains a maximum value. In
this stage TP is increasing at an increasing rate.
• MP>AP and MP reaches its maximum
• This stage is known as increasing returns to a
variable factor.
 Reasons
• The reasons for increasing returns are:-
1. Underutilisation of fixed factor(land)
2. Indivisibility of factors
3. Specialisation of labour
A rational producer will not operate in this stage
because the producer can always expand
through stage I.
STAGE II: Stage of Diminishing Returns
• It is the most important stage of all the three stages. Stage
II of production ranges from where MP curve is maximum
to the point where MP curve is zero, that is from A to B. MP
curve is positive but declining. TP curve increases at a
decreasing rate and reaches a maximum, in this stage, the
TP increases but less than proportionately to increase in
labour.
• MP≥0,AP>MP and TP is increasing at a diminishing rate.
• A rational producer will operate in this stage. The law of
diminishing returns will operate in Stage II.
• This is the BEST stage of production as TP reaches its
MAXIMUM.
 Reasons
• The reasons for diminishing returns are:
1. Optimal use of fixed factors
2. Lack of perfect substitutes between factors
 STAGE III: Negative Returns
• It covers the entire stage over which MP curve
is negative. In this stage TP curve falls after
point B. This is technically inefficient stage of
production.And a rational producer will never
operate in this stage.
• MP<0, TP is falling.
 Reasons for Negative Returns
1. Over utilization of fixed factors. i.e. labour