47. The Law of Diminishing Returns
The law of diminishing returns explains that if other resources are kept constant and only one resource is continuously increased, then production initially increases to a certain limit but eventually starts to decline. This is related to temporary overproduction.
According to Professor Benham, in the combination of production resources, the proportion of one resource is gradually increased. Gradually, after a point, the marginal and average production of that resource begins to decline.
Key Points:
Production is dependent on other resources being constant and is influenced by adjustments.
All aspects of adjustable resources are considered simultaneously.
Constant resources are limited.
At a technical level, there is no further adjustment.
Three Stages:
"No one can serve two masters." Either they will neglect one and love the other, or they will prefer one over the other.
First Stage
With constant resources, the incremental increase in adjustable resources leads to increased production. We get increasing production in the beginning. Initially, Total Product (TP), Marginal Product (MP), and Average Product (AP) all increase. This is known as the stage of increasing returns.
Second Stage (Diminishing Returns)
In this stage, both MP and AP start declining, but they remain positive. This stage ends when MP becomes zero. Here, TP reaches its maximum, and MP is zero, while TP increases at a diminishing rate.
Third Stage (Negative Returns)
In this stage, MP becomes negative, meaning the marginal returns turn negative, which causes TP to decrease. Due to diminishing marginal returns, this stage is called the stage of negative returns.
The law of diminishing returns explains all three stages.
Example (Question 48)
Given:
𝑃
=
8
,
𝑃
1
=
6
,
𝑄
=
32
,
𝑄
1
=
42
P=8,P
1
=6,Q=32,Q
1
=42
We calculate:
Δ
𝑃
=
𝑃
−
𝑃
1
=
8
−
6
=
2
ΔP=P−P
1
=8−6=2
Δ
𝑄
=
𝑄
−
𝑄
1
=
32
−
42
=
−
10
ΔQ=Q−Q
1
=32−42=−10
Price Elasticity of Demand (Ed):
𝐸
𝑑
=
Δ
𝑄
Δ
𝑃
×
𝑃
𝑄
Ed=
ΔP
ΔQ
×
Q
P
𝐸
𝑑
=
−
10
2
×
8
32
=
−
80
64
=
1.25
Ed=
2
−10
×
32
8
=
64
−80
=1.25
Since
𝐸
𝑑
>
1
Ed>1, demand is elastic or highly responsive to price changes.
Question 49: Monopoly Market
A monopoly market is a situation where there is only one producer or seller of a good or service. Due to the absence of competition, new firms face significant barriers to entry.
In a monopoly market:
There is only one producer, so there is no distinction between the firm and the industry.
A single buyer dominates the market, and the seller has full control over the supply of the good.
Price Determination:
In a monopoly, demand and supply create an inverse relationship. The marginal revenue (MR) is less than the average revenue (AR), and the monopolist is a price maker. Price determination depends on the monopolist's control over supply and demand. If the seller wants to increase sales, they must reduce prices. Thus, in a monopoly, the price is determined solely by the monopolist.
Question 50: Central Bank
In all countries, a central bank oversees the banking system. It is governed and managed by the government. The central bank controls the nation's monetary and banking policies and acts as the bank of all other banks.
In India, the Reserve Bank of India (RBI) is the central bank, established in 1935.
Functions of the Central Bank:
Issuance of Currency Notes:
The central bank has the sole right to issue currency notes in all countries. It regulates the supply of money and credit.
Bank of Banks:
The central bank serves as the banker to all other banks and maintains their reserves. When banks face liquidity issues, the central bank provides loans in times of need.
Government's Banker, Agent, and Adviser:
The central bank acts as the banker, agent, and adviser to the government.
