1. What are the key points in short run production functions that delineate the three stages of production? Explain the relationship between the law of diminishing return and three stages of production.
Short run production function
studies the effect on output due to change in variable input, assuming no
change in other factors. As there is change in variable input only, the ratio
between different inputs tends to change at different levels of output. This
relationship is explained by the slopes, shapes, and interrelationships of the
total, marginal, and average product curves. It shows the nature of rate of
change in output due to a change in only one variable factor of production
Key points in short run production functions that delineate the three stages of production
The key points in short run
production functions that delineate the three stages of production are slopes,
shapes, and interrelationships of the total, marginal, and average product
curves.
The total product curve is a reflection of the firm’s overall
production and is the basis of the two other curves. The average product curve is the quantity of the total output
produced per unit of a "variable input," such as hours of labor. The marginal product curve is slightly
different: It measures the change in product output per unit of variable input.
For example, if the average curve depicts the number of units produced based on
an overall number of employees, the marginal curve would show the number of
additional units produced if one more employee is added.
Since both average and marginal
products are derived from total product, the average and marginal product
curves are closely related to the total product curve. The input-output
relationship showing total, average and marginal productivity can be divided
into three stages of production and a set of product curves is presented in the
diagram. The variable input in this example is labor and the fixed factor is
capital.
Stage I
- The total
product curve has a positive slope.
- TP increases
at increasing rate increasing and MP also increases.
- Marginal
product is greater than average product. Marginal product initially increases
then decreases until it is equal to average product at the end of Stage I.
- Average product is positive and the average product curve has a positive slope.
Stage II
The three product curves reveal the following patterns in
Stage II.
- The total
product curve has a decreasing positive slope. In other words, the slope
becomes flatter with each additional unit of variable input.
- Marginal
product is positive and the marginal product curve has a negative slope.
The marginal product curve intersects the horizontal quantity axis at the
end of Stage II.
- Average
product is positive and the average product curve has a negative slope.
The average product curve is at its a peak at the onset of Stage II. At
this peak, average product is equal to marginal product.
- TP increases
at decreasing rate and MP falls. This phase ends when MP becomes zero and
TP reaches its maximum point:
Stage
III
- The total
product curve has a negative slope. It has passed its peak and is heading
down.
- Marginal
product is negative and the marginal product curve has a negative slope.
The marginal product curve has intersected the horizontal axis and is
moving down.
- Average
product remains positive but the average product curve has a negative
slope.
- TP starts
decreasing and MP not only falls, but also becomes negative.
Relationship between the law of diminishing return and three stages of production.
Law of
diminishing returns states that as more and more of the factor input is
employed, all other input quantities remaining constant, a point will finally
be reached where additional quantities of varying input will produce
diminishing marginal contributions to total product. It states that marginal
product diminishes when proportion between variable and fixed factors increase
beyond a point.
Three stages of
production in short run is an extension to Law of Diminishing Returns as it
also considers the phase of rising MP in addition to falling MP. The common
element between both is that MP is bound to decrease sooner or later with increase
in units of variable factor.
Short-run production Stage I arise
due to increasing average product. As more of the variable input is added to
the fixed input, the marginal product of the variable input increases. Most
importantly, marginal product is greater than average product, which causes
average product to increase. This is directly illustrated by
the slope of the average product curve.
In Stage II, short-run production
is characterized by decreasing, but positive marginal returns. As more of the
variable input is added to the fixed input, the marginal product of the
variable input decreases. Stage two is the period where marginal returns start
to decrease. Each additional variable input will still produce additional units
but at a decreasing rate. This is because of the law of diminishing returns:
Output steadily decreases on each additional unit of variable input, holding
all other inputs fixed.
Stage III of production function results
due to negative marginal returns. In this stage of short-run production, the
law of diminishing marginal returns causes marginal product to decrease so much
that it becomes negative. Stage III production is most obvious for the marginal
product curve, but is also indicated by the total product curve. Adding more
variable inputs becomes counterproductive; an additional source of labor will
lessen overall production.
Diminishing returns to a factor can
be understood with the help of total and marginal product curves. Total Product
rises first to an increasing rate in stage I and later at a diminishing rate in
stage II. At stage II, Total Product remains constant. Correspondingly when TP
is rising at an increasing rate, MP and AP curves are rising; and when total
product is rising at a diminishing rate, the MP and AP curves are declining.
When TP becomes constant, the MP becomes zero, and additional labour beyond
this level makes MP negative.
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
i.e. law of diminishing return is the only important range for a rational firm
in a competitive situation to operate in.
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