In the short run, output may be varied by varying the quantity (quantities) of the variable factor (s), while keeping the quantity (quantities) of other factors constant. The behaviour of output in such situation actually falls into three distinct stages.
In Fig. 8.2, we have graphically illustrated the production function with one factor variable (for the sake of convenience), while all other factors are held constant. Quantity of the variable factor is shown on the X-axis and total product, average product and marginal product are measured along the Y-axis.
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The variations in the total, average and marginal product by varying the quantity of variable factor are shown in this figure. Here, total product (TP) goes on rising to a point and after that it starts falling. Average and marginal product curves also rise and then decline. However, marginal product curve falls earlier than the average product curve. Three stages of the law are explained here.
Stage I (Stage of Increasing Returns):
In this stage, total product increases at an increasing rate from origin till point ‘C’. It is clear from the Fig. 8.2, where the slope of the total product curve (TP) increases upto point ‘C’ (TP curve is concave upwards upto this point).
Thus, marginal product rises upto point ‘D’ vertically downwards to point ‘C’. This shows that the firm is moving towards optimum combination. Rising marginal product also pulls up the average product. From point ‘C’ onwards during the stage I, the total product continues to rise, but, at a diminishing rate (total product is concave downwards), i.e., marginal product falls, but, is positive.
The point ‘C’ where the total product stops rising at a diminishing rate is called the point of inflexion. The average product, however, will continue to rise even after the point of inflexion, as marginal product (though falling) exceeds its average product.
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Rising average product indicates increase in the efficiency of labour. The marginal product of the variable factor is equal to the average product of the factor at point ‘E’.
The stage I end, where the average product reaches its highest point. So, here, efficiency of labour is maximum. This stage is known as the stage of increasing returns, as average product of the variable factor rises throughout the stage and marginal product of the variable factor rises in a significant part of this stage.
In stage I, total product is not fully utilized. The quantity of the fixed factor is too much relative to quantity of variable factor so that if some of the fixed factors are withdrawn, the total product would increase.
Thus, in the first stage, marginal product of the fixed factor is negative. No rational producer will choose to produce in this stage even if the fixed factor costs nothing (in which case, he will stop at the end of first stage, i.e., at point ‘A’). Producer can expand production by increasing quantity of the variable factor and make efficient use of the fixed factor.
Stage II (Stage of Diminishing Returns):
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In stage II, the total product continues to increase at a diminishing rate, until it reaches the maximum point ‘F’ where the second stage ends. In this stage, both the average product and marginal product of the variable factor are diminishing (but not negative), the latter falling at faster rate.
That is why; this stage is known as the stage of diminishing returns. With falling average product curve, efficiency of variable factor decreases and that of fixed factor continues to rise. The average product of the variable factor exceeds the marginal product of the factor throughout this stage.
At the end of second stage, i.e., at point ‘B’, marginal product of the variable factor is zero (corresponding to the highest point ‘F’ of the TP curve). This stage is very crucial. It is the stage of operation. A rational producer will always seek to produce in this stage, where both the average and marginal product are falling.
In the words of Joan Robinson, “The Law of Diminishing Returns as it is usually formulated, states that with a fixed amount of any factor of production, successive increases in the amounts of other factors will, after a point, yield diminishing increments of output”.
Stage III (Stage of Negative Returns):
In stage III, total product declines. So, marginal product of the variable factor becomes negative and falls below the X-axis. This stage is called the stage of negative returns, as total product, average product and marginal product fall during this stage and the average product of the variable factor is non-negative. In this stage, efficiency of variable as well as fixed factor declines and factor ratio is highly sub-optimal. Producer should reduce the amounts of variable factor.