Returns to a Factor

Commonly referred to as factor productivity, the returns to a factor can be described as the short-term relationship between the output and the input. The productivity generated from one production unit will be the same as the output generated. The factor’s productivity is calculated with an assumption that all other factors remain unchanged. 

Today, in this article on the understanding of returns to a factor, you will get detailed information on the concept of returns to a factor, an introduction to the law of diminishing returns, risk-adjustment return, its significance and other related topics such as demand and supply. So, without further ado, let us start with the introduction of returns to a factor in the economics study material.

Concept of Returns to Factor 

The returns to factor are related to the overall behaviour of the total output as only one variable input. Generally, the returns to a factor is a short-term concept. It further consists of three major factors – 

• Constant returns to a factor 
• Increasing returns to a factor 
• Diminishing returns to a factor. 

The change in productivity can result into – 

• Total productivity – The total physical product, also known as the total productivity, can be referred to as the total output generated at the input’s varied levels of a particular factor. 
• Marginal productivity – The marginal physical product or the marginal productivity is referred to as an additional output generated by adding more units of factor while keeping all other factors untouched or constant. 

Law of Diminishing Marginal Productivity

In economics, the law of diminishing marginal productivity, also termed as the law of diminishing marginal returns, is a critical law, according to which if one factor of the input is increased without touching the other factors, it will reflect a massive decline in the product output with regards to the per unit of added input. 

In simpler words, in case any production factor is increased while all other factors are constant, the productivity will boost up. However, if the input is raised, the output will tend to decline, and ultimately will become negative. 

Significance of Law of Diminishing Returns

According to the law of diminishing returns, the result of adding a production factor leads to an increase in the output. There are several ways in which the law of diminishing returns is important. The optimisation theory in mathematics explains the law of diminishing returns. 

When Demand Changes 

There are several factors that lead to changes in demand for a product. These include –

• Value of the essential commodities
• Forecast of change in prices
• Value of substitute items
• Per capita income
• Population
• Preferences

The price of the product is highly determined by the increase or the decrease of the prices. 

Let’s take a look. 

Demand increases 

Every time the supply of the product remains constant, the demand rapidly rises. As a result, the demand curve shifts to the right. If it continues to rise for a longer time, it surely impacts the equilibrium price. As a result, the rise in price leads to competition between producers. 

Demand decreases 

Considering the supply of the product remains constant, if its demand falls with time at a steady speed, the demand curve tends to shift leftwards. In such cases, the condition of excess supply appears at the level of equilibrium. This condition increases the competition between all producers.

Changes in Supply 

There are several reasons that could lead to the change in the supply of a product. These include – 

• The expectation of future price change
• Technological advancement
• Cost of factors of production
• Number of manufacturers
• Cost of competitive products
• Aim of companies
• Taxes levied

When Supply Changes 

In case there are alterations in the supply of the product, there are changes in the supply-demand curve. It can occur if – 

Supply increases

If the demand remains the same, but the supply changes, the supply curves move towards the right. As a result, when the product supply increases, its demand at the level of equilibrium also rises. This condition gives rise to competition in the market which leads to a fall in product prices. 

Supply decreases 

If the demand for the product remains the same, but the supply changes, the supply curve moves towards the left. As a result, when the supply of the product falls, it increases the demand to the level of equilibrium. 

Change in both supply and demand

Apart from the situations, there are several other market situations that make the supply-demand relationship even more complicated. Here are four major market situations that arise in the real-world scenario- 

• Demand decreases, supply decreases 
• Supply increases, demand decreases 
• Demand increases, supply increases 
• Supply decreases, demand increases 

Conclusion 

With this, we end our study material on the returns to a factor. In these returns to a factor notes, we studied the law of returns to a factor that can be described as the short-term relationship between the output and the input. The productivity generated from one unit of production will be the same as the output is extracted. 

We covered the introduction to returns to a factor, the introduction to the law of diminishing returns, its significance and other related topics such as demand and supply in detail. We hope the returns to a factor study material will help attain a better understanding of this topic.