Law
of Variable Proportions states that as more and
more of the variable factor is combined with the fixed factor, marginal product
of the variable factor may initially rise, but eventually a situation must come
when marginal product of the variable factor starts declining. Marginal Product
may ultimately become zero or even negative.
The
Law of variable proportion is based on certain assumptions. These are as
follows:
(i)
Ratio in which factors of production are combined can be changed.
(ii) Units of variable factor are homogenous or
equally efficient and are increased one by one.
(iii) State of Technology does not change.
Three
Stages of Production
Law
of Variable proportion suggests three stages of production (also called three
phases of production) as follows:
Stage
I- Stage of Increasing Returns: When MP is
increasing and TP is increasing at an increasing rate.
Stage
II- Stage of Diminishing Returns: When MP is
diminishing and TP is increasing at a decreasing rate.
Stage
III- Stage of Negative Returns: When MP is
negative, and TP is declining in absolute terms.
Significance
of the Stages of Production
Q1.
Will you as a producer stop in the stage I of production?
Answer:
No, because in stage I, employment of every additional unit of the variable
factor (other things remaining constant) is giving more and more marginal
output. The producer remains lucratively profitable in this stage.
Q2.
Will you as a producer enter in stage III of production?
Answer:
No. Because in stage III, employment of
every additional unit of the variable factor (other things remaining constant)
is causing loss in Total Output as MP is negative. In fact, it is foolish to
get into a situation when total output declines even when the cost of
production is rising on account of addition employment of the variable
factor.
Q3.
In which stage will producer stop and find his equilibrium?
Answer:
As discussed in questions 1 and 2 above that a producer will neither stop in
stage I nor enter stage III. Hence, the producer will obviously attain his
equilibrium (where he maximizes his profit) at some point in stage II where MP
is declining but remains positive.
Causes
of Increasing Returns to a Factor
1.
Fuller utilization of the fixed factor
2.
Division of Labour resulting in increase in efficiency
3.
Better coordination between the factors
Causes
of Diminishing Returns to a Factor
1.
Fixity of factor
2.
Imperfect factor substitutability
3.
Poor Coordination between the Factors
Relationship
Between TP and MP
(i)
As long as MP is increasing, TP is increasing at an increasing rate.
(ii)
When MP starts declining, TP continues to increase but at a decreasing rate.
(iii)
When MP is Zero, TP is maximum.
(iv)
When MP is negative, TP starts declining in absolute terms.
Relationship
Between MP and AP
(i)
AP increases as long as MP >AP
(ii)
AP decreases when MP < AP
(iii) AP is at its maximum where AP=MP. MP cuts AP
from above at its maximum.
(iv) MP can be zero or even negative, but AP
continues to be positive.
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