Law Of Variable Proportion.doc

Managerial economics is a study orscience that deals with the application of managerial skills in economics, concepts and techniques to business management in order to help to find problems or obstacles in the business and provide solution for those problems. Problems may be relating to costs, prices, fore casting the future market, human resource management, profits, methodology to decision making problems faces by private, public and non-profit making organizations etc.

The science of economics is concerned with the allocation of scarce resources to alternative uses so as to achieve maximum possible satisfaction of the people thus

Lord Robins defines economics as a “ science which studies human behaviour as a relationship between ends and scarce means which have alternative uses”. Spencer and Seigelmanthat “Managerial Economics is the integration of economic theory with business practice for the purpose of facilitating decision making and forward planning by the management”. Mc Nair and Meriam, “Managerial economics is the use of economic modes of thought to analyze business situation”.

Douglas - “Managerial economics is .. the application of economic principles and methodologies to the decision-making process within the firm or organization.”

Pappas & Hirschey - “Managerial economics applies economic theory and methods to business and administrative decision-making.”

Salvatore - “Managerial economics refers to the application of economic theory and the tools of analysis of decision science to examine how an organisation can achieve its objectives most effectively.” The type of decision making by managers to business firms also usually involves question of resource allocation within a firm or organisation. The resources at the disposal of a firm are scarce or limited. What product to be produced, what price should be fixed, how much quantity of it should be produced, and what factor combination or production technique be used for the production of goods involve resource allocation by a firm. It is the task of a manager of a firm that it should take decisions regarding these resource allocation problems in a way that ensure most efficient use of resources . only this will enable the firm to achieve the goal of maximisation of profits.

Managerial

economics is a highly specialized and a new branch of economics developed in resentyears. It highlights on practical application of principles and concepts of economics in to business decision making process in order to find out optimal solutions to managerial problems. It fills up the gap between abstract economic theory and managerial practice. It liesmid way between economic theory and business practice and serves as a connecting link between the two.

Management

science is concerned with the allocation of scarce resources at the disposable of the firm. While economics is primarily concerned with the allocation of scarce resources so as to achieve maximum social welfare management science deals particularly with organising and allocating a firm’s scarce resources so as to achieve the objective of the individual firm which generally happens to be maximisationof its profits. Therefore, management science’s is intimately related to economics.

Features of managerial Economics

It is a new discipline and of recent origin with highly specialized and separate branch by itself. It is basically a branch of microeconomics and as such it studies the problesof one firm in detail. It is more realistic, pragmatic and highlights on practical application of various economic theories to solve business and management problems. It is a science of decision making ,concentrated on decision making process, decision models and decision variables and their relationship. Both conceptual and metrical and it helps the decision maker by providing measurement of various economic variable and their interrelationships. It uses various macro economic concept-tslike national income, inflation, deflation, trade cycles etc. to understand and adjust its policies to the environment in which the firm operates. It also gives importance to the study of non-economic variables having implications of economic performance of the firm. For example, impact of technology, environmental forces, socio-political and cultural factors etc.

Managerial Economics

does not provide ready-made solutions to all kinds of problems faced by a firm. It provides only the logic and methodology to find out answers and not the answers themselves. It all depends on the manager’s ability, experience, expertise and intelligence to use different tools of economic analysis to find out the correct answers to business problems.

SCOPE OF MANAGERIAL ECONOMICS

The term scope indicates the area of study, boundaries, subject matter and width of a subject. Business economics is comparatively a new and upcoming subject. Consequently, there is no unanimity among different economists with respect to the exact scope of business economic. However, the following topics are covered the scope of managerial economics.

OBJECTIVES OF A FIRM The primary objective of firms is to make maximum possible profits. Therefore a firm makes the above decisions in a way that minimizes its cost to produce a given level of output. But in the context of present day business environment, many new objectives have come to the fore. Some of them are competitive while others are supplementary in nature. A few others are inter- connected and a few others are opposing in nature. A few other……..SAME AS ON PAGE 2 TILL PAGE 3 MAXIMIZATION TODAY.

DEMAND ANALYSIS AND FORECASTING

A firm is basically a producing unit. It produces different kinds of goods and services. It has to meet the requirements of consumers in the market. The basic problems of which goods and services a firm should produce is a significant decision a firm has to make and where to produce, for whom to produce, how to produce. How to organize the production of goods and services by combining and coordinating the productive resources it employs , how much to produce and how to distribute them in the market are to be answered by a firm and all these decision relies on the market price system that serves as a source of incentives and information net work . As relative market prices of goods or services change due to the changes in their demand and supply the buyers or users will substitute the relatively cheaper goods or services for the expensive ones. In response to the changes in demand for goods and guided by price signals etc. , a firm has to study in detail the various determinates of demand, nature, composition and characteristics of demand, elasticity of demand, demand distinctions, demand forecasting and so on. The production plan prepared by a firm should take all these points into account.

PRODUCTION AND COST ANALYSIS

The other important decision to be taken by business firms relates to the choice of a technique of production. Production implies transformation of inputs into outputs. It may be either in physical or monetary terms. The physical production deals with how output is to be produced by a firm by employing different factor inputs in proper proportions. Production involves the use of particular combination of factors, especially labour and capital to produce a commodity. Usually variousalternative techniques of producing a commodity are available among which a firm has to choose. Some production involve the use of relatively more labour as compared to capital and are therefore called labourintensive techniques. Scarcity of resources demands that goods should be produced with the most efficient method. If the economy uses its resources inefficiently, the output would be smaller and there would be unnecessarily sacrifice of goods that otherwise would have been available. Therefore it is in firm’s interest that the technique of production which is used minimises the cost of production for producing a given level of output. Cost controls, cost reduction, cost cutting and cost minimization receive top most priority in production and cost analysis. Maximization of output with minimum

cost is the basic slogan of any firm. Cost analysis deals with the study of various cost concepts, their classification, cost-output relationship in the short run and long run.

PRICING DECISIONS, POLICIES AND PRACTICES

Pricing of a product by a business firm is an important decision that has to be made by a manager. This depends on pricing policy and practices adopted by a firm. Price setting is one of the most important policies of a firm. Price of a product will determine to a good extent how much quantity of its product it will be able to sell Price along with cost per unit and output sold will determine its profits. In deciding about price of its products, a firm has to estimate of demand and production cost will determine how much quantity of output it should produce to maximise its profits. A profit is the difference between revenue and cost. Demand for a product tells the firms the quantities of a product that can be sold at various prices, and cost output relationship determines the cost per unit that has to be incurred by producing different levels of output. Thus, demand together with cost determines the profit possibilities of producing a product.

Hence, we have to study price output determination under different market conditions, objectives and considerations of pricing policies, pricing methods, practices, policies etc. we also study price forecasting, marketing channel distribution channel sales promotion policies etc.

PROFIT MANAGEMENT

Balance in the other computer

Describe the production function with one variable input. Explain the relationship between TP, MP AND AP curves and the three stages of production?

Ans2

A businesses firm is an economic unit. It is alsocalled

as a production unit. The process of adding value to intermediate goods or providing services for value may be called production. The economic unit that performs the production activity is known as firm or producer. Production is one of the most important activities of a firm in the circle of economic activity. The main objective of production is to satisfy the demand for different kinds of goods and services of the community. The production theory help the management to answer the question that what combination of input would minimise cost, how the change in scale of production affect the cost and how can the least cost combination of inputs be achieved and the like question.

The relation between inputs and output of a firm has been called the Production Function.

PRODUCTION FUNCTION

A Production Functionexplains the relationship between factor input and output in physical terms. Or the term PRODUCTION means transformation of physical “inputs” into physical “outputs”. In other words, it shows that with a given state of technology and during a particular period of times how much can be produces with give amount of inputs. It also explains how output changes with the change in the quantity of inputs.

The entire theory of production centre round the concept of production function. “A production Function“ expressthe technological or engineering relationship between physical quantity of inputs employed and physical quantity of outputs obtained by a firm. It specifies a flow of output resulting from a flow of inputs during a specified period of time. It may be in the form of a table, a graph or and equating specifying maximum output rate from a given amount of inputs used. Since it relates inputs tooutputs, it is also called “input-output relation.” The production is purely physical in nature and is determined by the quantum of technology, availability of equipments, labourand raw materials, and so on employed by a firm.

Aproduction function can be represented in the form of a mathematical model of equation as Q = f ( a,b,c,…… etc.) where Q stands for quantity of output per unit of time and a, b, c, etc are the various factor inputs like land, capital, labouretc which are used in the production of output. The rate of output Q is thus a function of the factor inputs a b c etc, employed by the firm per unit of time. There is a positive function relationship implying that the output varies in the same direction as the inputs quantities. In other words, if all other inputs are held constant, the output will increase uptoa limit if the quantity of one input is increased. It has been observed that a raw material bears a constant relation to output at all levels of production.

In economic theory there are two types of factor inputs are:FIXED INPUTS : Fixed inputs arethose factors the quantity of which remains constant irrespective of the level of output produced by a firm. For example, land, buildings, machines, toos, equipments, superior types of labor, top management etc.

VARIABLE INPUTS : Variable inputs are those factors the quantity of which varies with variations in the levels of output produced by a firm for example, raw materials, power fuel, water, transport and communication etc.

The distinction between the two will hold good only in the short run. In the long run, all factor inputs will become variable in nature.

The distinction between the two will hold good only in the short run. In the long run, all factor inputs will become variable in future.

Short run is a period of time in which only the variable factors can be varied while fixed factors like plants, machineries, top management etc would remain constant. Time available at the disposal of a producer to make changes in the quantum of factor inputs is very much limited in the Short run.

Long run is a period of time where in the producer will have adequate time to make any sort of changes in the factor combinations.

It is necessary to note that production function is assumed to be a continuous function, i.e. it is assumed that a change in any of the variable factors produces corresponding changes in the out put. Generally there are two types of production functions. They are as follows.

1.SHORT RUN PRODUCTION FUNTCION In this case, the producer will keep all fixed factors as constant and changes only a few variable factor inputs. In the short run, we come across tow kinds of production functions.

a)

Quantities ofall inputs both fixed and variable will be kept

b)

constant and only one variable input will be varied. For example, Law of Variable Proportions. Quantities of all factor inputs are kept constant and only two variable factor inputs are varied. For example, Iso-quants and Iso-cost curves .

2.LONG RUN PRODUCTION FUNCTION

In this case, the producer will vary the quantities of all factor inputs both fixed as well as variable in the same proportion. For example, the laws of returns to scale. Each firm has its own production function which is determined by the state of technology, managerial ability, organizational skills etc of a firm. If there are any improvements in them, the old production function is disturbed and a new one takes its place. It may be in following manner

a) b) c)

The quantity of inputs may be reduced while the quantity of output may remain same. The quantity of output may increase while the quantity of inputs may remain same. The quantity of output may increase and quantity of inputs may decrease.

Production function with one variable input case The law of Variable Proportions This law is one of the most fundamental laws of production. It gives us one of the key insights to the working out of the most ideal combination of factor inputs. In the short-run the level of production can be changed by changing the factor proportions. This law examines the production function with on factor variable, keeping the other factors quantities fixed. In other words this law explains the short-run production function. When the quantity of one input is varied, keeping other inputs constant, the proportion between factors changes. When the proportion of variable factors increases, the total output does not always increase in the same proportion, but in varying proportion. In other words All factor inputs are not available in plenty. Hence, in order to

expand the output, scare factors must be kept constant and variable factors are to increased in greater qualities. Additional units of variable factor on the fixed factors will certainly mean a variation in output. The law of variable proportions or the way of non – proportional output explains how variation in one factor input give place for variations in outputs. The law can be stated as the following. As the quantity of different units of only one factor input is increased to a given quantity of fixed factors, beyond a particular point, the marginal, average and total output eventually decline.

This is why the law is named’ Law proportions’.

of

Variable

The law of variable proportion is the new name given to the famous ‘Laws of Diminishing Returns. ‘The law of variable proportion’ or the law of diminishing returns has been defined by a number of economists.

In the words of F. Benham. “As the proportion of one factor in a combination of factors is increased, after a point, first the marginal and then the average product of that factor will diminish”. This law explains return to a factor.

In the words of. Marshall

An increase in the quality of a variable factor added to fixed factors, at the end results in a

less than proportionate increase in the amount of product, given technical conditions.

Assumptions of the Law 1. Only one variable factor unit is to be varied while all other factors should be kept constant. • Different units of variable factor are homogenous. • Techniques of production remain constant. • The law will hold good only for a short and a given period. • There are possibilities for varying the proportion of factor inputs. Thus, the law states that if more and more units of a variable factor are applied to a given quantity of fixed factor, the total output may initially increase at an increasing rate but beyond a certain level the total output, the rate of increase in total output eventually diminishes in the use of additional units of the variable factor. The volume of goods produced can be looked at form three different angles viz.

Illustration A hypothetical production schedule is worked out to explain the operation of the law. Fixed factors + 1 Acre of land + Rs 5000-00 capital. Variable factor= labor Units inputs

of

Variable

TP units

in AP IN MP UNITS UNITS

IN

(Labor)s 0 1 2 3 4 5 6 7 8 9 10

0 10 24 39 52 60 66 70 72 72 70

0 10 12 13 13 12 11 10 9 8 7

0 10 14 15 13 8 6 4 2 0 -2

Total Product or Output: (TP) refers to the total volume of goods produced during a specified period of time. Total product (TP) can be raised only by increasing the quantity of variable factors employed in production. For instance, more shirts will be produced when more labor and capital are used. Total product (TP), generally goes on increasing with an increase in the quantity of the factor services employed. But there is a limit to which total product can increase with increase in the quantity of variable factors of production, basically it is the output derived from all factors

units, both fixed & variable employed by the producer. It is also a sum of marginal output

Average Product (AP). Average product can be known by dividing total product by the total number of units of the variable factor. AP=Total Product Units of variable factor

Marginal Product or Output: (MP) It is output derived from the employment of an additional unit of variable factor unit. The rate at which total product increases is known as marginal product. We also

define marginal product as the addition to the total product resulting from a unit increase in the quantity of the variable factor. Initially marginal product rises, but ultimately it begins to fall down, it becomes zero and at last becomes negative. It would be seen that the total product is maximum when the marginal product is zero.

It can be easily seen that the average product also show almost the same tendency as does the marginal product. Initially, both the marginal product and the average product rise but ultimately both of these fall. However, marginal product may be zero. The output does not increase at a constant rate as more of any one input is added to the production process. For example on a small plot of land. We can improve the yield by increasing the fertilizer use to some extent. However, excessive use of fertilizer beyond the optimum quantity may lead to reduction in the output instead of any increase as per the law of Diminishing Returns (for instance, single application of fertilizers may increase the output by 50 per cent, a second application by another 30 per cent and the third by 20 per cent. However, if we apply fertilizer five to six times in a year, the output may drop to zero).

The principle of diminishing marginal productivity (returns) states that as additional units of a variable inputs are added to other inputs that are fixed in supply, the increment to output eventually decline (for a constant technology). This phenomenon has been widely observed and there is enough empirical evidence to support it. For business managers, managers, marginal productivity of an input plays an important part in determining how much of that input will be employed.

Trends in Output From the table. One can observed the following tendencies in the Total product (TP), Average Product ( AP) & Marginal Product ( MP).

1. Total output goes on increasing as long as MP is positive. It is the highest when MP is zero and TP declines when MP becomes negative. 2. MP increases in the beginning, reaches the highest point and diminishes at the end. 3. AP will also have the same tendencies as the MP. In the beginning MP will be higher than AP but at the end AP will be higher than MP. Diagrammatic reprisetation

In the above diagram along with OX - axis, we measure the amount of variable factors employed and along OY-Axis, we measure TP, AP & MP. From the diagram it is clear that there are III stages. Or the law speaks about three stages of production.

STATE NUMBER 1. THE LAW ON INCREASING RETURNS The first stage goes from origin to the point where the average output is maximum i.e. P because corresponding to this point P the MP is rising and reaches its highest point. When a firm expands output by increasing the quantity of variable factors in proportion to fixed it moves towards optimum combination of factors of production. After the point P, MP decline and as such TP increases gradually. In this stage the law of increasing return may be said to operate and marginal product begins to fall i.e law of diminishing returns set in. The First stage comes to an end at the point where MP curve cuts the AP curve when the AP is maximum at N. The I stage is called as the law of increasing returns on account of the following reasons.

STANGE NUMBER II. RETURNS

THE LAW OF DIMINSHING

The second stage goes from the point where the average output is maximum to the point where the marginal output is zero. After having attained the optimum. Combination of the fixed inputs and the variable input, if the firm increases still further the quantity of the variable input, the per unit output of the variable input falls. In this stage, total output rises but only at a diminishing rate.

STAGE NUMBER RETURNS

III

THE

STATE

OF

NAGATIVE

The third stage covers the range over which the marginal output is regative and total output naturally falls. No producer will operate at this stage, even if he can procure the variable input at zero price.

The first and the third stages are known as stages are known as stages of economic absurdity or economic non-sense. A producer will always seek to operate in the second stage. At which point the producer will operate in this stage will depend upon the prices of the factor inputs. In the following figures we have drawn TP and units of variable upmost in one figure and AP and MP and units of variable inputs in the other figure. In both the table and the graphic representation e see that both average and marginal products first increase reach the maximum and eventually decline.

Note that MP-AP a the maximum of average product function. This is always the case if MP>AP, the average will be pushed up by the incremental unit and if MP,AP, the average will be pulled down. It follows that the average product will reach its peak where MP=AP.

Assumptions. The application of the law is subject to the following assumptions: (i)

(ii) (iii) (iv)

Technique of production remain unchanged. Prices of inputs is given and do not change. Units of the variable factors are homogeneous. Factor proportion can be altered.

The diminishing return stage of the law is almost universal. This, generally, applies to every productive activity.