Whether they are film producers of multimillion-dollar epics or small firms that market a single product, suppliers face a difficult task. Producing an economic good or service requires a combination of land, labour, capital, and entrepreneurs. The theory of production deals with the relationship between the factors of production and the output of goods and services. The theory of production is generally based on the short run, a period of production that allows producers to change only the amount of the variable input called labour. This contrasts with the long run, a period of production long enough for producers to adjust the quantities of all their resources, including capital.
The Law of Variable Proportions state that, in the short run, output will change as one input is varied while the others are held constant. The Law of Variable Proportions deals with the relationship between the input of productive resources and the output of productive resources and the output of final products. The law helps answer the question: How is the output of the final product affected as more units of one variable input or resource are added to fixed amount of other resources? Of course, it is possible to vary all the inputs at the same time. Economists do not like to do this, however, because when more than one factor of production is varied, it becomes harder to gauge the impact of a single variable on total output. When it comes to determining the optimal number of variable units to be used in production, changes in marginal product are of special interest.
There are three stages of production — increasing returns, diminishing returns, and negative returns — that are based on the way marginal product changes as the variable input of labour is changed. In stage one, the first workers hired cannot work efficiently because there are too many resources per worker. As the number of workers increases, they make better use of their machinery and resources. This results in increasing returns (or increasing marginal products) for the first five workers hired. As long as each new worker hired contributes more to total output than the worker before, total output rises at an increasingly faster rate. This stage is known as the stage of increasing returns. In stage two, the total production keeps growing, by smaller and smaller amount. This stage illustrates the principle of diminishing returns, the stage where output increases at a diminishing rate as more units of variable input are added. The third stage of production begins when the eleventh worker is added. By this time, the firm has hired too many workers, and they are starting to get in each other's way. Marginal product becomes negative and total plant output decreases.
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