LAW OF VARIABLE PROPORTION

Law of Variable Proportions.

This law explains the effects on output of variations in factor - proportions.

It refers to the amount of extra output produced by adding to a fixed input more and more of variable input. 

There are three stages to the law,

Stage 1: Increasing Returns Stage. The output increases at an increasing rate.

Stage2: Diminishing Returns Stage. The output increases at a diminishing rate. 

Stage 3: Negative Returns Stage. The Total Product declines and the marginal product becomes negative cutting the x - axis.

This the Total Product, Marginal Product and Average Product pass through three different stages.

COST AND COST CURVES

The Fixed capital of the firm,eg, equipment, machinery, building etc. is part of the fixed cost. The cost that does not vary with the change in output is called FIXED COST. 

VARIABLE COST is the cost that varies with output. For eg. labour, raw materials, fuel, power. As the output increases the variable cost also increases.

Total cost= Total Fixed Cost+ Total Variable Cost.

OR

                     TC= TFC+ TVC

TFC is constant and this cost is born by the producer even if his production is zero. Therefore, this curve is parallel to x axis.

TVC is a rising curve because as the output increases there is more requirement for variable input. 

TC is the total of both TFC and TVC.

Theory of Production- Laws of Returns

Theory of Production- Laws of Returns.

In these laws the economic unit is the individual firm which tries to maximize it's producf-- output through a rational combination of the factors of production at its disposal.

The theory of production is divided into two heads : 1) laws of Returns and 2) Production Function.

Production

It is the result of the co-operative working of the various factors of production- land, labour, capital and entrepreneurship.

Marginal Revenue

Marginal Revenue is the change in total revenue resulting from an increase in sale by an additional unit of the product in a particular time. 

Average Revenue Curve

Average Revenue is the revenue per unit of the commodity sold. It can be calculated by dividing total revenue by the number of units sold to the customers.

Average Revenue= Total Revenue÷Number of units sold to the customers.

Consumer Surplus.

Consumer Surplus may be defined as the excess of utility obtained by the consumer over utility obtained by the consumer over utility forgone or disutility suffered.

It is measured by the difference between the maximum price which the consumer is willing to pay for a commodity rather than go without it and the price which he actually pays for it .

Marshall defined it as " The excess of price which a person would be willing to pay rather than go without the thing, over that which he actually does pay is the economic measure of this surplus of satisfaction. It may be called as

Consumer Surplus".

Elasticity of Supply.

Elasticity of Supply.

It is a parallel concept like the Elasticity of Demand. It may be defined as the responsiveness of the sellers to a change in the price of the commodity. It relates to the reaction of sellers to a particular change in price of the commodity.

Cross Elasticity of Demand

Cross Elasticity of demand.

It is the change in quantity demanded of commodity A due to the change in price of commodity B. The commodities can be either substitute or complementary. It tells us who the demand for any commodity depends upon the price of related goods.

Ec= proportionate change in quantity demanded of commodity A/ proportionate change in price of commodity B

Cross Elasticity of Demand for two goods may be positive ( substitute), negative ( complementary) and zero( not related).

1. Case of positive Cross Elasticity of Demand.

2. Case of negative Cross Elasticity of Demand

3. Case of Zero Elasticity of Demand

Income Elasticity of Demand and its cases.

Income Elasticity of Demand:

It can be defined as the proportionate change in quantity demanded of the commodity to a given proportionate change in Income of the consumer.

Ei= proportionate change in quantity demanded / proportionate change in Income.

We can classify into five cases:

1) Zero Income Elasticity of Demand.

In this case the quantity purchased of a commodity will remain unchanged irrespective of the change in Income.  Ei=

2) Negative Income Elasticity of Demand.

In this case, when the money- income of the consumer increases the quantity demanded by the consumer decreases. For eg. Inferior goods  Ei<0

3) Unitary Income Elasticity of Demand.

In this case when the money- income of the consumer increases, the quantity demanded by the consumer increases by the same amount.  Ei = 1 For eg. Comfort goods.

4) Income Elasticity greater than unity.

When the consumer spends a larger proportion of his increased income on the commodity when he becomes richer. For eg. Luxuries. Ei>1

5) Income Elasticity of Demand less than unity: when the consumer spends less proportion of his income on the puchase of a commodity. For eg. Necessities.Ei<1

Types of Elasticities

The term elastic and inelastic are  only  relative terms. Elasticity is a matter of degree only. Based on these, there are five classifications of Elasticities are given below:-

1) Perfectly Elastic demand.

2) Perfectly Inelastic demand.

3) Relatively Elastic demand.

4) Relatively Inelastic demand.

5) Unit Elasticity of demand.

1) Perfectly elastic demand: when a small change in price results in in an infinite Lee large change in demand it is a case of perfectly elastic demand.

In the above diagram, at a given price OP the quantity demanded remains infinite. Any price above or below OP , the demand becomes zero.

2) Perfectly Inelastic demand: This is a case when there is almost no change in demand with a change in price.

 In the given figure, there is no change in the quantity demanded. When the price is zero people demand the same amount of the commodity. For eg. Necessities ( salt)

3) Relatively Elastic demand:- In this case a small change in price leads to a more than proportionate change in demand.

In the figure given above, , when the fall in price from P to P1 causes a more than proportionate change in demand from M to M1.For eg. Luxury goods.

4) Relatively Inelastic demand:-  In this case, when a large change in price results in less than proportionate change in demand. 

In the figure given above, when the price falls from P1to P2 , there is a less than proportionate increase in quantity demanded.

5) Unit Elasticity of demand:- In this case, when a change in price in followed by an equally proportionate change in Demand. 

In the figure given above, when the price decreases from P1 to P2, the quantity demanded also increases in equal propotion, from A to B. 

Price Elasticity of Demand

Price Elasticity of demand is the ratio of proportionate changes in the quantity demanded of a commodity to a given proportionate change in price. In other words , it is the ratio of relative change in quantity demanded to the relative change in price.

E= Relative Change in Quantity /Relative Change in Price.

Indifference Map

Indifference map

An indifference map of a consumer represents his tastes and preferences as between different combinations of them. It represents his scale of preferences. The map changes when his taste and preferences change. 

 In the above diagram, curves1,2,3,4 are the various indifference curves and any combination of wheat and rice on curve 1 will give the same satisfaction on the curve 1. Whereas point A gives lower satisfaction than point B, B lower than point C and C lower than point D.A<B<C<D. The higher the curve the higher the satisfaction. 

Indifference schedule

Indifference schedule is a statement of various combinations of two goods that will be equally acceptable to the consumer. The various combinations give equal satisfaction so he becomes indifferent to various other combinations

Indifference curve analysis

Indifference curve analysis is based on ordinal approach. The curve shows different combinations of two commodities which give the consumer an equal satisfaction. The combination of commodities can vary but for simplicity two commodities have been taken.