Thelawofvariableproportions

OrShortrunproductionfunction/returntofactor
Definition
TheLawofVariableProportionswhichisthenewnameofthefamousLawofDiminishing
Returns.
AccordingtoStigler"Asequalincrementsofoneinputareadded,theinputsofother
productiveservicesbeingheldconstant,beyondacertainpoint,theresultingincrementsof
producewilldecreasei.e.,themarginalproductwilldiminish".
AccordingtoPaulSamulson"Anincreaseinsomeinputsrelativetootherfixedinputs
willinagivenstateoftechnologycauseoutputtoincrease,butafterapoint,theextra
outputresultingfromthesameadditionofextrainputswillbecomeless".
Thelawofvariableproportionsstatesthatasthequantityofonefactorisincreased,keepingthe
otherfactorsfixed,themarginalproductofthatfactorwilleventuallydecline.Thismeansthat
uptotheuseofacertainamountofvariablefactor,marginalproductofthefactormayincrease
andafteracertainstageitstartsdiminishing.
AssumptionsofLaw:

ConstanttechnologyThislawassumesthattechnologydoesnotchangethroughoutthe
operationofthelaw.
Fixedamountofsomefactors.onefactorofproductionhastobefixedforthislaw.
Possibilityofvaryingfactorproportionsthislawassumesthatvariablefactorscanbe
changedintheshortrun.
alltheunitsofvariablefactorarehomogenous
inputpricesremainunchanged
outputismeasuredinphysicalunits

Threestagesoflawofvariableproportion
Stage1(stageofincreasingreturn):thevariableinputisbeingusedwithincreasingoutputper
unit,thelatterreachingamaximumatpointB(sincetheaveragephysicalproductisatits
maximum at that point). Because the output per unit of the variable input is improving
throughoutstage1,apricetakingfirmwillalwaysoperatebeyondthisstage.
Stage2(stageofdiminishingreturns): outputincreasesatadecreasingrate,andtheaverage
andmarginalphysicalproductaredeclining.However,theaverageproductoffixedinputs(not
shown)isstillrising,becauseoutputisrisingwhilefixedinputusageisconstant.Inthisstage,
theemploymentofadditionalvariableinputsincreasestheoutputperunitoffixedinputbut
decreasestheoutputperunitofthevariableinput.Theoptimuminput/outputcombinationforthe
pricetakingfirmwillbeinstage2,althoughafirmfacingadownwardslopeddemandcurve

mightfinditmostprofitabletooperateinStage1.

Stage 3(stage of negative returns): too much variable input is being used relative to the
availablefixedinputs.Variableinputsareoverutilizedinthesensethattheirpresenceonthe
marginobstructstheproductionprocessratherthanenhancingit.Theoutputperunitofboththe
fixedandthevariableinputdeclinesthroughoutthisstage.Attheboundarybetweenstage2
andstage3,thehighestpossibleoutputisbeingobtainedfromthefixedinput.

LongRunProductionReturnstoScale
Inthelongrun,allfactorsofproductionarevariable.Howtheoutputofabusinessresponds
toachangeinfactorinputsiscalledreturnstoscale.Lawofreturntoscaleisconcernedwith
thestudyofproductionfunctioninlongrun.Achangeinscalemeansthatallinputsorfactors
arevariedinsameproportion,keepingthefactorproportionsconstant.Whenthequantitiesofall
factorsarechangedalongaparticularscale,sizeofthefirmandscaleofoutputwillchange.
Aswebegintomodelproductioninthelongrun,wewillsimplifytheproductionfunction
somewhatas:
Q=f(L,K)
Q=quantityofcommodityproduced
K,L=Capital&Labour

When we double the factor inputs from (150L + 20K) to (300L + 40K) then the
percentagechangeinoutputis150%thereareincreasingreturnstoscale.
Whenthescaleofproductionischangedfrom(600L+80K0to(750L+100K)thenthe
percentagechangeinoutput(13%)islessthanthechangeininputs(25%)implyinga
situationofdecreasingreturnstoscale.

Increasingreturnstoscaleoccurwhenthe%changeinoutput>%changeininputs
Decreasingreturnstoscaleoccurwhenthe%changeinoutput<%changeininputs
Constantreturnstoscaleoccurwhenthe%changeinoutput=%changeininputs

Thenatureofthereturnstoscaleaffectstheshapeofabusinessslongrunaveragecostcurve.
Numericalexampleoflongrunreturnstoscale
UnitsofCapital UnitsofLabour
20
40

150
300

TotalOutput %Change
Inputs
3000
7500
100

60
80
100

450
600
750

12000
16000
18000

50
33
25

in %Change
Output

in Returns
Scale

150

Increasing

60
33
13

Increasing
Constant
Decreasing

to

PossibleCasesinLongRunPeriodofProduction
Thelongrunperiodofproductionusuallyanalyzestheeconomiesofscalewhichstudiesthe
increasingreturnstoscaleoreconomiesofmassproduction.Ittendstoprovidedinformation
abouttheunitcostandthesizeofoperationintheproductionofgoods.Theeconomiesofscale
primarilydirectedtoreducetheunitcostsfromtheincreasingsizeoftheoperation.Thatiswhy
thelargerfirmsaremoreeconomicallyviableinthelongrunproductionasitdiminishesthe
productioncost.Takenotethattheeconomiesofscaletendstoincreaseinspecializationand
divisionoflabor.Thismayleadtoincreaseproductioninputsandexpandstheproductionoutput.
1.DecreasingReturnstoScale(IncreasingCost):Whenthefirmbecomeslargeitislikelyto
encounterproblemintheproductionofaparticularproductbecauseoftheincreaseaverage
costofoperation.Thisistheproblemofmanagementwhenincreaseofproductioninputby
60%theproductionoutputreachesonlyto40%.Inthisnotiontheproductionislesscheapat
acertainscalewhenitisalreadylargeinscale.Itrequireslargescalemachineryordivision
oflabortoproducegreaterproductionoutput.Hence,theDecreasingReturnstoscaleoccur
whenthepercentchangeinoutputisgreaterinpercentforthechangeininputs.

2. ConstantReturnstoScale(ConstantCost):Thereisatimeforafirmtoenjoyalongrange
ofproductionoutputforwhichtheaveragecostisthesameproportiontobothproduction
inputandoutput.Ifthereisanincreaseofthenumberofmachinesby50%thenthereisalso
anincreaseofthenumberofunitsproducedby50%.Thisisaconstantreturnsinmachinery
production. Hence, the Constant Returns to scale occur when the average cost do not
increaseasaresultofdiseconomiesofscale.

3. IncreasingReturntoScale(DecreasingCost): Thisisknownastheeconomiesofscale
whereinthefirmsincreaseinallproductioninputsandoutputs.Supposingafirmincreases
the inputs by 50% the return of scale increases to 60%.The economies scale expands
productive capacity in the long run as it operated by machines and other sophisticated
technologythatmayreducetheoverheadcostinproducingtheproducts.Thisismoreon
capitalintensiveproductionwhereintherearemoreequipmentutilizethanworkersinthe
productionprocess.Inthelongrun,themanufacturingsectorswithhighcapitalinvestment
ofequipmentresultstohigherproductionoutputthatexpandstheprofitabilityofthefirms.
The economiesofscale arethereductionofunitcostinthelongrunofoperation.The
expansionofthefirmthroughamassproductionprovidesgreaterunitsofoutput.

Differencebetweenreturntofactor&returntoscale
ThedifferencebetweenreturnstoavariablefactorandreturnstoscaleflowfromtheLawof
DiminishingReturnsandmustbeunderstoodintheparametersoftheconceptsofshortrunand
longrun.
Shortrun(returntofactor)isaperiodwhenproductioncanbeincreasedonlywithincreasein
variablefactorsbecausefixedfactorsareconstant;thefirmscannotchangetheirsizesandscales
intheshortrun.Whenoutputisincreasedbymorequantitiesofvariablefactorswiththefixed
factorheldconstant,thetheproportionbetweenthefixedandvariablefactorschangesandthe
changeinoutputfollowstheLawofVariableProportionsintermsofwhichinitiallythetotal
rises at a higher rate, then it become constant because marginal product reaches zero and
eventuallyitfalls.Thislocusofthemarginalproduct(MP)i.e.incrementaloutputiscalledthe
LawofVariableProportions.
Longrun(returntoscale)isdefinedasaperiodwhichallowsthefirmtochangetheirsizesand
scalestoincreaseoutputi.e.inthelongrunallfactorsarevariablebuteveninthiscaseinitially
thereareincreasingreturnstoscalei.e.thetotaloutputriseswithfastspeed,thenitbecomes
constantandeventuallythetotaloutputfallsbecausemarginalproduct(MP)becomesnegative.
ThissituationissubservienttotheLawofDiminishingReturnstoScale.
Thebasicdifferencebetweenthelawsofreturnstoavariablefactorandthelawsofreturnsto
scaleliesintheassumptionsonwhichtheselawsarebased.
1. Incaseofthelawsofreturnstoavariablefactor,onlyoneinputisvariableallother
inputs remainingconstantwhereasincaseofthelawsofreturns toscale,allthe
inputsarevariable.

2. Thelawofreturnstoavariablefactorisashortrunphenomenonbecausesupplyofcapitalin
the short run is inelastic. On the contrary, the laws of returns to scale are a long run
phenomenonbecausesupplyofalltheinputsinthelongruniselasticandmoreandmoreof
alltheinputscanbeemployed.Intheanalysisoftheinputoutputrelationship,therefore,in
caseofthelawofreturnstoavariablefactorasinglevariableproductionfunctionisused
whereasincaseofthelawsofreturnstoscaleatwovariableproductionfunctionisused.