Law of Variable Proportion

The law of variable proportion states that as more and more units of variable factors are applied to the given quantity of a fixed factor, the total product may increase at an increasing rate initially, but eventually it will increase at a diminishing rate.

Explaining the above law by taking an example:

A farmer is producing wheat, he has land as a fixed factor and labour as a variable factor.

Since land is a fixed factor, he can produce more of wheat only by using more and more of labour.

Will every additional unit of labour employed on the given land yield the same amount of additional output of wheat?

No, it can never happen. If MP (marginal product/additional output) of labour was to remain constant, then a country like India would have produced more and more of wheat using more and more of labour on the same piece of land. It would have never faced the problem of food.

So MP eventually dimnish.This is due to the fact that, there is some ideal ratio of factors of production.

Relation between TP/MP and AP/MP curves

1) Relation between Total product(TP) and Marginal Product(MP) 

We will explain the relation between TP and MP by the below graph:

marginal product

1) So long as  MP is increasing , TP is increasing at increasing rate.
MP is rising till point ‘b’ in the second graph and so is TP is increasing at increasing rate till point ‘a’ in the first graph.

Price Ceiling

In countries like India essentials of life, like certain food grains or life saving medicines, are often found to be extremely scarce.

Their prices are often found to be high. Poor population found it difficult to buy them. Such a situation often compels the government to intervene in the market with Price Ceiling. 

It means fixing a maximum price for a commodity which is generally much below the equilibrium market price.

Ceiling means maximum limit. Price ceiling means the maximum price of a commodity that the seller can charge from the buyers for a particular good and service. It is also termed as Maximum price Legislation.

Price Ceiling Policy

Let us understand the implication of price ceiling policy through the below graph.

Price Ceiling

DD and SS are the demand and supply curve respectively. OP is the equilibrium price and OQ is the equilibrium quantity. E is the point of equilibrium.

Time Element and Equilibrium Price

Equilibrium price is determined by the industry at that point where total demand is equal to total supply.

But, whether demand will have more effect or supply on the determination of the price, will depend on how much time will it take for the demand and supply to stabilize.

Importance of time element in the determination of price has been first examined by Dr. Marshall.

According to him, shorter the time period, greater will be the influence of demand in price determination and longer the period, greater will be the influence of supply on prices.

Marshall has divided the time elements into four periods:

1) Very short period or market period

2) Short period

3) Long period

4) Very long period

Very short period or market period

It is the time period during which supply of a commodity can be increased only up to the extent of its existing stock.

In case of perishable commodity which cannot be stored, supply becomes absolutely fixed or perfectly inelastic.

Some special cases of equilibrium

We have already explained the effects of change in demand and supply on the equilibrium price and quantity when demand and supply curves are normal slope, i.e. negatively sloping demand curve and positively sloping supply curve.

Let us consider how increase and decrease in demand affect equilibrium price in two exceptional situations:

1) When supply of the commodity is perfectly elastic        

2) When supply of the commodity is perfectly inelastic

When supply of the commodity is perfectly elastic

When supply curve is perfectly elastic i.e. supply curve is parallel to X axis, increase or decrease in demand  for a commodity does not cause any change in its price, equilibrium quantity tends to change. 

This is shown in the graph below:

perfectly elastic

E is the initial point of equilibrium when perfectly elastic supply curve(SS) intersect demand curve (DD). OP is the equilibrium price and OQ is the equilibrium quantity.

Forward shift in demand curve from DD to D₁D₁ leaves price of the commodity unchanged at OP. Equilibrium quantity increases from OQ to OQ₁.Equilibrium point shifts to E₁.

Backward shift in demand curve from DD to D₂D₂ leaves price of the commodity unchanged at OP. Equilibrium quantity decreases from OQ to OQ₂. Equilibrium point shifts to E₂.