Demand and Law of Demand

Introduction
• Goods like air which are free gifts of nature and are available in
unlimited quantity are known as free goods and they do not
command a price;
• By contrast, economic goods are scarce and they command a price;
• Thus, economic goods like clothes, food, cars, etc have a price
because they are useful as well as scarce in their availability;
• It is only that economic goods are useful that they are demanded by
the people, and only because they are scarce that sellers are prepared
to sell them at a price;
• Therefore, prices of goods and services in free enterprise economy
are determined by the interaction of market forces of demand and
supply.
Meaning of Demand

• Demand for a commodity refers to the quantities of a commodity

which consumers are willing and able to purchase at various
possible prices during a particular period of time;
Key points:

• Demand and desire are different: desire is just a wishful thinking. It is

only when this desire is backed by willingness and ability/ power to
purchase that makes a demand. Therefore, demand is an effective
desire.
• Demand in economics is always at a price- different quantities of
commodities will be purchased at different prices.
• Demand is always expressed in reference to certain time period-thus,
demand is a flow concept;
 Determinants of Demand/Factors affecting demand
• Price of the commodity: inverse relationship. As the price of the commodity rises,
demand for the same falls and vice versa.
• Income of the consumer: 1. Normal Goods (NG): demand for which increases with
the increase in income of the consumers and decreases with fall in income. eg:
articles of comfort an luxury-clothes, refrigerator, cars, TV sets, etc which make our
life enjoyable and comfortable fall under this category.
• 2. Inferior Goods (IG): demand for which falls with the increase in the income of the
consumer and increases with the fall in income. Consumers purchase inferior goods
more at lower level of income. consumers may substitute maize, jowar with rice or
wheat when the income increases.
• 3. Inexpensive Necessities (IN): eg: salt and matchbox, quantity purchased increases
with increase in income up to a certain level and thereafter it remains constant,
irrespective of the level of income.
• This functional relationship between demand of the commodity and the
level of income id called Income demand.
• Consumer’s tastes and preferences: Taste and preferences depend upon
social customs, habits, fashion, lifestyle, etc. as the tastes/preferences
change, so does the demand for the products.
• Price of related goods:
• 1.Substitute/ Competitive Goods: those goods which satisfy the same
type of need and hence can be used in place of one another to satisfy a
given want.
• 2. Complimentary Goods: complementary to one another in the sense
that they are consumed/used jointly to satisfy a given want.
• Consumer’s expectations: if a consumer expects a rise in the price of
the commodity in future, they would demand greater amount of the
commodity today with a view to avoid purchasing it at a higher price
in future and vice versa.
• Consumer credit facilities: if consumers are able to get facilities or
they are able to borrow from the banks, they would be tempted to
purchase certain goods they could not, otherwise. Eg: demand for
cars in India has increased partly because of easy availability of loan
facility.
• Demonstration effect: refers to a tendency of a person to emulate the
consumption style of other persons such as his friends, neighbours,
etc
• Size and composition of population: Population size determines no.
of consumers (direct relationship).increase in size of the population
will increase the demand for the commodity. Composition includes
various facets of population like no. of children, adults , males,
females, etc. if youngsters constitute majority of the population,
demand for cricket bats, jeans, disco, etc will increase.
• Distribution of income: unequal distribution leads to more
purchasing power with the rich people, therefore they will demand
more luxury goods like cars, LED TV. Equal distribution will lead to less
demand of luxury goods and more demand for essential (necessity)
goods.
• Climatic factors: different goods are needed on different climates.
Demand for ice, ACs. Fans, cold drinks, cotton cloth increases in
summers.
• Government policy: economic policy of the government also
influences the demand for commodities.as the taxes are imposed,
prices shoot up, demand falls.
Demand Function

• D= F(p,pr, y, DY,GP, TP,CRFAc)

 Law of Demand: Statement of the Law
• The law of demand states that, other things remaining equal, the quantity
demanded of a commodity increases when its price falls and decreases when
its price rises.
• Assumptions:
✓ No change in the income of the consumers
✓No change in the tastes and preferences of the consumers
✓ Prices of related commodities should remain unchanged
✓Commodity should be a normal commodity
✓Size, age composition of population should not change
✓Distribution of income should not change
✓ expectations for future prices should not change
Demand Schedule: Tabular statement that shows
different quantities of a commodity that would be
demanded at different prices during a given period

• Individual demand schedule : different quantities of goods which an

individual consumer is willing to buy at different prices during a given
period of time
• Market demand schedule: different quantities of goods which all
consumers in the market are willing to buy at different prices during a
given period of time
Individual and Market demand schedule
Price (Rs. Per Qty demanded by A Qty demanded by B Total market
Kg.) (Kg per week) (Kg per week) demand (A+B) (Kg
per week)
(1) (2) (3) (4)
100 1 2 3
90 2 3 5
80 4 5 9
70 6 7 13
Reasons for downward slope of demand curve
• 1. Law of diminishing marginal utility: with the increase in the units of a
commodity consumed, every additional unit of commodity gives lesser
satisfaction to the consumer (details, later)
• 2. Income effect: change in demand on account of change in the REAL
INCOME resulting from a change in the price of a commodity is known as
the income effect.
• 3. Substitution Effect: effect that a change in the relative prices of
substitute goods has on the quantity demanded. When the price of a
commodity falls and the price of its substitutes remain unchanged, it
becomes relatively cheaper in comparison to its substitutes.
• Income Effect+ Substitution effect= Price effect
• 4. Several Uses of Commodity: when prices of commodities are high, they
will be used for more important uses and a small quantity will be in
demand and vice versa.
Movement along the demand curve and Shift in the
demand Curve

• Movement along the demand curve: Change in quantity demanded;

• When the quantity demanded of a commodity changes (rises or falls)
as a result of the change in its own price, while other determinants
remain constant, it is known as change in the quantity demanded.
• Types: Extension (Expansion) of demand curve
• Contraction of demand curve
Increase in demand curve: Rightward Shift in the demand curve
Decrease in demand curve: Leftward Shift in the demand curve
 Concept of Utility
• The law of demand states that as the price of a commodity falls, the
amount purchased of it increases;
• But the question is – How does a consumer decide how much of a good
to buy at a given price and why does he buy more of a good when its
price falls?

• The answer to this lies in the theory of consumer behaviour , with the
objective of explaining the principles behind the law of demand.
• Various theories have been developed from time to time and the
prominant ones are:
Contd.
• 1. Cardinal Utility Analysis- Marginal Utility Analysis
• 2. Ordinal Utility Analysis- Indifference Curve Analysis
Marginal Utility Analysis
• Every consumer has to buy a number of goods and services with the
limited income;
• A basic assumption of economic theory of household behaviour is
that the consumer is rational. i.e he tries to maximise the total utility
from the purchase;
• An important question that a consumer has to decide is : how he
should allocate his given income on different goods and services so as
to maximise total utility.
• Therefore, A consumer will be in equilibrium when he
spends his given income on the purchase of different
goods in such a way so as to maximise his total utility.
• The utility approach assumes that the utility which consumer gets
from a unit of a commodity can be measured in ternms of some
quantifiable unit in the same way as we measure the weight or height
of person.
• According to this approach, utility can be measured in cardinal or
definite numbers like 1,2,3,4, etc.
How can a household maximise its total utility?
• The general rule is that the consumer will maximise total utility
when he allocates his income among various commodities in such a
way that the marginal utility of the last rupee (or any other unit of
money) spent on each commodity is equal.
Meaning of utility- Total and Marginal Utility
• Utility refers to want satisfying power of a commodity;
• Ability or capacity of a commodity to satisfy human want;
• In objective terms, utility can be defined as the amount of satisfaction
derived from the consumption of a commodity;
Characteristics of utility:
• Utility is subjective: utility depends upon the individual’s own subjective estimate
of the amount of satisfaction he is likely to get a commodity;
• Utility is not measurable: Since utility is subjective it cannot be measure in
objective terms as satisfaction is not measurable; however, some economists like
Marshall assume that utility is measurable in monetary terms, by the amount of
money the consumer is willing to pay for a unity of the commodity. Some
economists measure utility in terms of subjective units called utils.
• Utility is relative in nature: relative to a person’s need. Utility of a commodity to a
person depends upon his intensity of desire for a commodity; the greater a need ,
greater is the utility. Utility varies from person to person, place to place, time to
time.
• Utility is different from usefulness: utility does not imply that a good is useful
too. Eg: smoking is injurious to health, even then it has utility as it satisfy desire
of a smoker
• Devoid of ethical connotations: utility has no moral legal or
ethical connotations
Total Utility
• Total Utility refers to the total satisfaction derived by the consumer
from the consumption of a specific quantity of a commodity;
• It is the increase in the total utility by consuming one more unit of a
commodity.

• It is clear from the example that marginal utility is the difference

between two successive total utility.

• i.e MUnth =TUn –Tun-1

Or
• TUn = MU1+MU2+MU3….MUnth
Utility schedule for mangoes
Units of mangoes TU (utils) MU (utils)
0 0 Undefined
1 10 10 (10-0)
2 17 7 (17-10)
3 21 4 (21-17)
4 22 1 (22-21)
5 22 0 (22-22)
6 19 -3(19-22)
Relationship between TU and MU
When TU is When MU is
Increasing at a decreasing rate Decreasing but positive
At the Maximum Zero
Decreasing Negative
Law of Diminishing Marginal Utility
• Statement of the Law: initially formulated by a German Economist
H.H. Gossen, but was given a systematic formulation by Alfred
Marshall.
• The Law states that as the amount consumed of a commodity
increases, other things being equal, the utility derived by the
consumer from the additional units i.e. marginal utility goes on
decreasing.
• According to Alfred Marshall, “The additional benefit a person
derives from a given increase in his stock of a thing diminishes with
every increase in the stock that he already has”.
Assumptions
• All the units of a commodity must be identical i.e. same in all respects;
• The unit of the good must be standard;
• There should be no change in the taste during the process of
consumption;
• There must be continuity in consumption and if a break in the continuity
is necessary, the time interval between the consumption of the two
units must be short;
• There should be no change in the prices of substitute goods.
• The utility is measurable
• The consumer is rational while taking consumption decisions
• Marginal utility of money is assumed to constant.
Consumer’s equilibrium through Cardinal Utility
Approach- one Commodity Case
• A consumer will be in equilibrium when he spends his given income on the
purchase of different goods and services so as to maximize his total utility.
• Assumptions:
• Consumer is Rational;
• Utility can be measured in money terms i.e. utility of one unit of a
commodity equals the amount of money (price) which a consumer is
prepared to pay for it;
• The Law of Diminishing Marginal Utility operates;
• Prices of other commodities, Consumer’s income are given;
• Tastes and preferences remain unchanged;
• Every unit of money has the same utility to the consumer.
Law of Equi-Marginal Utility
• Every consumer has to buy a large number of goods and services with
his limited income;
• Therefore, a consumer will be in equilibrium when he allocates his
given income on the purchase of different goods in such a way that he
maximises his total utility from his expenditure on different goods;
• The law states:
• “The utility maximising consumer must allocate his income among
various commodities in such a way that the last unit of money
(rupee) spent on each commodity gives him the same (equal)
marginal utility”.
• The utility maximising consumer will spend his money income on different
goods in such a way that marginal utility of each good is proportional to its
price;
• The consumer will maximise utility when the ratio of marginal utilities
derived from different goods and their prices is equal;
• This is known as the proportionality rule.
• The consumer will be in equilibrium while purchasing X and Y, when,
• MUx/Px = MUy/Py=MU per unit of Money.
• Here MUx/Px explain the marginal utility of a unit of money spent on
commodity X. Similarly, MUy/Py explain the marginal utility of a unit of
money spent on commodity Y
Limitations
Budget Line
• Indifference curve show the tastes and preferences of the consumer;
• But in order to know what quantities of the two goods will be
purchased by the household, we must also know how much
expenditure the household wants to incur on these two commodities
and what are the prices of these commodities.
• This information on expenditure the household and prices of these
commodities enables us to draw a budget line;
• While indifference curve tells us what choices the household would
like to make; the budget line tells us what the household can do;
Illustration:
• Suppose the consumer has 200 Rs to spend on food and clothing and
that the price of food is Rs 20 per unit and price of clothing is Rs 40
per unit.
• How much of food and clothing can the consumer buy, given the
consumer’s expenditure and prices of two commodities?
These combinations represent the maximum amounts that can be
purchased with an expenditure of Rs 200 at the given prices of food
and clothing;
All the combinations of clothing and food are shown on the line , called
as the ‘budget line’ or ‘price line’.
Thus, a budget line shows various combinations of two commodities
which can be purchased with a given budget at given prices of the two
commodities;
Consumer’s Equilibrium through Indifference Curve
Approach
• A consumer attains his equilibrium when he maximises his
satisfaction, given his income and prices of the two commodities.
• As is clear from the figure, the highest indifference curve with a point
on the budget line is the one to which the budget line touches;
• This occurs at point T.
• The Tangency states the highest indifference curve that the consumer
can achieve, subject to the budget constraint.
 Elasticity of Demand
• The law of demand states that the amount demanded of a
commodity is influenced significantly by the price of the commodity.
• But the information about the extent to which demand respond to
the change in the price (or any other factor) is provided by elasticity
of demand;
• The credit for introducing the concept of elasticity of demand goes to
the great economist Alfred Marshall;
Meaning
• In general, Elasticity of demand refers to the degree of
responsiveness of quantity demanded of a commodity to a change in
any of its determinants, namely price of the commodity, price of
other commodities, income of the consumers, etc.
Types:
• There are mainly three types of elasticity of demand :
• 1. Price elasticity of Demand
• 2. Income elasticity of Demand
• 3. Cross elasticity of Demand
HOMEWORK

• Examples of each type of price elasticity

Price elasticity of Demand
• Price elasticity of demand may be defined as the degree of
responsiveness of quantity demanded of a commodity in response to
change in its price.
• Price elasticity of demand refers to the ratio of the percentage change
in the quantity demanded of a commodity to a given percentage
change in its price;
• Thus:
• ep= percentage change in quantity demanded/percentage change in
price;
• Where, ep denotes price elasticity of demand.
Classification of Price Elasticity
• Perfectly inelastic demand: when quantity demanded of a commodity does
not respond to a change in its price, then the elasticity of demand is zero;
• Cases of perfectly inelastic demand are very rare.
• However, in case of life saving medicines, the demand for such medicines is
considered to be perfectly inelastic.
• Perfectly elastic demand: when consumers are prepared to purchase all that
they can get at a particular price but nothing al all at a slightly higher price,
then the price elasticity of demand for a commodity is said to be infinite;
• A very small fall in the price of the commodity causes the demand to increase
infinitely.
• Cases of perfectly elastic demand is very rare.
• Unitary elastic demand: when a given percentage change in the price
of a commodity causes an equivalent percentage change in the
quantity demanded, then the elasticity of demand is said to be
unitary or one;
• Rarely found in real life.
• Elastic demand: when the percentage change in the quantity demanded of a
commodity exceeds the percentage change in its price, the elasticity of demand is
greater than unitary.
• If the fall in the price of the commodity by 10 per cent causes an increase in
amount demanded by 15 per cent, the demand is said to be elastic. Generally,
demand for luxury goods is elastic in nature.
• Demand curve is elastic between A and B because the percentage change in
quantity demanded from OQo to OQ1 is relatively larger than the percentage
change in the Price from OPo to OP1
• Inelastic demand: demand is inelastic when the percentage Change in the
quantity demanded of a commodity is less than the percentage change in its
price.
• Demand curve is elastic between C and D because the percentage change in
quantity demanded from OQ2 to OQ3 is relatively smaller than the
percentage change in the Price from OP3 to OP4
Factors affecting price Elasticity of demand
• Availability of substitutes: if available, elastic for the current commodity.
• Nature of commodity: necessity, like food items – inelastic. luxury or a
comfort- for both, consumption can be postponed as they are not the
essential commodities. (elastic)
• Proportion of income spent: soap, matchbox, salt (inelastic) smaller the
proportion of income spent on the items, inelastic is the demand. Even if
the price increases a little, since the consumer spends a small proportion of
the income, it will not make much of a difference, hence inelastic demand.
• The number of uses of commodity: If the price of the commodity is very
high, consumer will purchase the commodity for the most important use,
and hence the demand will be very small. As the price falls, more of the
commodity will be bought to be devoted to less important use. Eg:
electricity (elastic)
• Time Factor: short period- inelastic, long period- elastic.
• Possibility of postponement of consumption: elastic if the
postponement of consumption is possible. The consumption of
clothing, furniture, air conditioner, etc can be postponed. Inelastic if
the postponement is not possible.eg: consumption of food items
cannot be postponed.
• Price range: demand for a commodity tends to be inelastic at very
high and very low prices, and elastic within the moderate range of
prices;
• Habits of the consumers: Whether a person is habitual of using a
commodity or not. If yes, they will continue to consume the
commodity even at higher prices. (inelastic)
• Income of the consumer: Rich consumers have inelastic demand. It is
because a rise or fall will not affect their pocket. On the other hand,
the demand of middle income and poor people is generally elastic as
a change in price of the commodity will much affect their budget.
Income Elasticity of Demand
• Income elasticity of demand measures the degree of responsiveness
of the quantity demanded of a commodity to a change in income of
the consumers;
• Income elasticity is defined as the ratio of the percentage change in
the quantity demanded of a commodity to the percentage change in
the income of the consumers.
• Formula:
• ey = percentage change in the quantity demanded / percentage change
in income
Types of income elasticity of Demand
• Positive income elasticity: quantity demanded increases as income
increases. i.e. normal goods.
• Negative income elasticity: quantity demanded decreases as income
increase. i.e. inferior goods.
• Zero income elasticity: quantity demanded remains unchanged as
income increases. i.e. essential goods.
Cross elasticity of Demand
• Cross elasticity of Demand is defined as the percentage change in the
quantity demanded of a commodity with respect to the percentage
change in the price of its related commodity.
• i.e. percentage change in the quantity demanded of commodity X
with respect to the percentage change in the price of its related
commodity Y.
• Formula: exy = percentage change in the quantity demanded of
commodity X / percentage change in the price of its related
commodity Y
Types of Cross elasticity of Demand
• Positive cross elasticity of demand: Substitute Goods
• Negative cross elasticity of demand: Complementary Goods
• Zero cross elasticity of demand: Unrelated Goods
Importance:

• Important for taking Business Decisions

• Important to Monopolist
• Determination of Factor Prices
• Assists in formulating Government Policies
• Important in the International Trade
• Incidence of Taxation
• Explanation of the ‘paradox of Plenty’
Supply: Law of Supply & Price Elasticity of
Supply
Concept of Supply
• In a free Enterprise economy, prices are determined by interaction of
market forces of Demand and Supply.
• The force of demand factor has already been taken up previously;
• In particular, the topic will explain the relationship between price and
the quantity supplied of a commodity in terms of law of Supply;
• Supply of a commodity refers to the quantities of a commodity
which producers or sellers are willing to produce and offer for sale
at various prices during a particular period of time;
Key aspects of the Concept
• Supply is a desired quantity, i.e. how much producers are willing to sell
and not how much they actually sell;
• Supply is always expressed with reference to some price. With a change
in the price of a commodity, its supply will also change;
• Like demand, Supply is also a flow variable; therefore, supply refers to
the amount which the producers are willing to sell during a specified
period of time- per day, per week, per month or per year;
• Thus, the statement that 200 cars will be supplied is an incomplete
statement;
• The complete and meaningful statement will be : at a price of Rs. 10
lakhs, 20 cars will be supplied per day by the car dealer.
Individual and Market supply
• Individual Supply refers to the quantity of a commodity which a firm
is willing to produce and offer for sale at a particular price during a
specified period;
• A group of Firms constitute an Industry;
• Therefore, the quantity that the producers are willing to produce and
offer for sale at a particular price during a specified period is known
as market supply or industry supply.
• Difference between Stock and Supply?
 Determinants of Supply
• Price of the commodity
• Goals of the producers
• Input prices
• Prices of related goods
• Techniques of production
• Structure of the Industry
• Policy of taxation and subsidy
• Expectations of future prices
• Natural factors
• Agreement of producers
• Availability of transport and communication facility
Supply Function

• Sn= f (pn, pn-1, G, F ,T,….)

Law of Supply: relationship between price and
supply
• The law of supply states that, other things remaining the same
(ceteris paribus), the quantity of any commodity that firms will
produce and offer for sale rises with a rise in its price and falls with a
fall in its price.
Individual and market supply schedule for
Good X
Time Period and Supply
Movement along the Supply Curve and Shift of Supply Curve
Movement along the Supply Curve
• When the quantity supplied changes as a result of change in its own
price of the commodity, other things remaining the same, it is known
as change in quantity supplied.
• When the quantity supplied of a commodity rises due to rise in its
own price, other factors remaining the same, it is called extension or
expansion (increase) of supply;
• On the other hand, when the quantity supplied of a commodity falls
due to fall in its own price, other things remaining the same, it is
called contraction of supply or fall in quantity supplied.
Shift of Supply Curve
• When the amount supplied of a commodity increases or decreases
because of change in factors other than the own price of the
commodity, it is called change in supply or shift of supply curve;
• An increase in supply refers to a situation when the producers are
willing to supply a larger quantity of the commodity at the same
price; (rightward shift)
• A decrease in supply refers to a situation when the producers are
willing to supply a smaller quantity of the commodity at the same
price; (leftward shift)
Price elasticity of supply
• Law of supply tells us the direction in which supply of a commodity
will change as a result of change in its price but does not give us the
magnitude of change in supply.
• Meaning:
• Price elasticity of supply measures the degree of responsiveness of
the quantity supplied of a commodity to a change in its price. It
measures the sensitivity of the quantity supplied of a commodity to a
change in its price.
Degrees of elasticity of Supply
• 1. perfectly elastic: quantity supplied of a commodity responds by an
infinite amount to a very small change in price;(i)
• 2. Perfectly inelastic: extreme case of supply elasticity in which there is no
supply response, no matter how large a price change take place. (ii)
• 3. Unitary elastic: when the percentage change in the quantity supplied of
a commodity is exactly equal to the percentage change in its price. (iii)
• 4. Elastic: when the percentage change in the quantity supplied of a
commodity is greater than the percentage change in its price. (iv) S5
• Inelastic: when the percentage change in the quantity supplied of a
commodity is less than the percentage change in its price. (iv) S6
Assignment- Determinants of Elasticity of Supply

• behaviour of cost of production

• Time element
• Nature of commodity
• Availability of facilities for expanding output
• Nature of inputs
• Nature of techniques of production
• Factor mobility
• Risk taking
• Expectation about future prices
Laws of Returns
Introduction
• The supply curve shows various quantities of a commodity that firms
would be willing to produce and offer for sale at various prices;
• The supply price depends upon the cost of production of that level of
output;
• Cost of production in turn depends upon relationship between input
and output and the prices of inputs;
• The study of relationship between input and output is known as
‘theory of production’;
Concept of production

• The act of making good and services and thereby adding utility to the
object is called production in economics;
Production Function
• Production process involves the use of various inputs or factor
services to produce output;
• For eg: to produce shoes , we require inputs such as shoe workers
,leather, glue, shoe making machines, etc.
• Output, thus, is a function of inputs like land, labour, capital, etc.
• The functional relationship between inputs and outputs is usually
referred to as ‘production function’.
• Therefore, a production function shows the maximum quantity of a
commodity that can be produced per unit of time with the given
amount of inputs , when the best production technique available is
used.
Important points to note:
• A production function is expressed with reference to a particular
period of time;
• Relationship between inputs and outputs;
• Given the state of technology.
Short Run and Long Run
• The nature of production function i.e. how output varies with a
change in the quantity of inputs, depends upon the time period
allowed for the adjustment of inputs;
• Economists normally distinguish between two time periods: Short run
and Long run;
Short Run
• Short run refers to the period of time during which the amount of one
or more inputs, called the fixed factors, cannot be changed;
• Eg: the amount of plant and equipment is fixed factor and cannot be
changed in the short run;
• This implied that an increase in the output in the short run can be
brought about by increasing those inputs that can be varied, known
as variable inputs.
• i.e. labour and raw material is a variable factor that can be increased
to increase production with a given quantity of fixed factors;
Long Run

• Time period during which all the factors of production can be varied
and there are no fixed factors;
• A firm in the long run can install new plant or set up new factory
building;
• Long run is the period during which size of the plant can be changed;
• Thus, all the factors are variable in the long run;
Duration
• Short period varies among industries;
• In some industries short period may extend over many years, say
steel industry where mere installing a small steel plant may take 3
years and this period is regarded as a short period OR small firm
producing consumer goods can acquire and operate a new equipment
in a matter of a few months.
Types of production Functions
• Short run: a short run production function refers to a situation when
only one input is variable and all other inputs are assumed to be
constant.
• The behaviour of output when only one input is changed and other
inputs are fixed is termed as ‘returns to a factor’.
• Short run production function Is the subject matter of law of variable
proportions or what the classical economists have named as ‘laws of
returns’.
• Qx= f(L)
• Long run production function studies changes in the output when all
the inputs used in the production of a commodity are changed
simultaneously and in the same proportion;
• The response of output to changes in the scale of all the factors in the
same proportion is termed as ‘returns to scale’.

• Qx= f(K,L)
Variation of output in the short run- returns
to a factor
• Capital is the fixed factor
• Labour is the variable factor
• By applying a simple 2 input model, we can find out how output will
vary as more of labour is applied to a given quantity of capital.
Basic concepts
Laws of variable proportion
• The law of variable proportion states that as more and more units of
a variable factor are applied to a given quantity of a fixed factor, total
product may increase at an increasing rate initially, but eventually it
will increase at a diminishing rate;
• Expressed in terms of marginal and average product, the law states
that if more and more units of a variable factor are applied to a given
quantity of a fixed factor, marginal product and average product of
the variable factor will eventually decrease (after increasing initially)
Assumptions of the law
• The state of technology is given and remains unchanged;
• Some inputs are kept fixed while others are varied;
• It is possible to change the factor proportions;
• All the units of the variable factor are homogeneous and are equally
efficient
Three stages of production
• Stage of increasing returns
• Stage of diminishing returns
• Stage of negative returns
Explanation of the Law of the Variable
Proportions
• Causes of increasing returns:
• 1. Fuller utilisation of fixed factors
• 2. Increase in efficiency
• Causses of diminishing returns:
• 1. Disturbing the optimum proportion
• 2. imperfect substitutability of the factors of production
Causes of negative returns
• 1. Overcrowding
• 2. Management Problem
Stages of operation and decision to produce
Returns to a factor- laws of returns ro a
variable factor
• Returns to a factor means change in the physical quantity of a good
when the quantity of one factor is increased while that of the other
factors remain constant;
• It is a short run phenomenon;
There are three possibilities of returns to a
factor
• Increasing returns to a factor
• Constant returns to factor
• Diminishing returns to a factor