In this article we will discuss about the optimum use of resources.
Production involves the combination of the services of the different factors, as very few economic tasks are performed by one factor alone. Thus, every productive unit, whether it be a factory or a farm or a railway, uses a number of different types of workers and equipment and other factors.
In the short run, it is usually found that the proportions between the different factors remain fixed and cannot be altered. Thus, a plant may be designed to employ a certain number of men, for example, one man to each machine.
In some cases, however, the proportion of the different factors remains more or less fixed all the time: one driver for one tax-cab, one ploughman for one plough, etc. But, the proportions are seldom absolutely fixed in the proportion of one to one, as these are subject to changes due to change in the methods of production or change in factor prices.
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In the long run, the proportions between the factors can usually be varied through the substitution of factors. The relative proportion of the different factors can be varied, as for example, machinery can be substituted for labour, oil for coal and so forth.
A firm is always eager to substitute the different factors to produce a given amount of output at the lowest possible cost. It substitutes one factor for another so long such a substitution can yield the same output at lesser cost. Under a price system, this substitution depends on the relative prices (and productivity) of the different factors.
The factor, say labour, should be substituted for another factor, say capital, so long as less than a rupee worth of labour can replace a rupee’s worth of capital and still yield the same output. In other words, if a unit of labour costs, say, two times as much as unit of capital, labour should be substituted for capital as long as a unit of labour can replace more than two units of capital and still yield the same output.
In this way, a given output will be produced at the lowest possible cost given the prices of the various factors; the combination of the factors which produces the given output at the lowest possible cost is known as the least-cost combination of factors.
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Neo-classical economists like Alfred Marshall and others used to explain the factor-combination and allocation with reference to the marginal productivity of each factor and its price. Suppose, the marginal product of a factor is 150 units of output and the price of the factor is Rs 15.
Then, 150 + 15, i.e., is the additional output resulting from the marginal rupee spent on the factor. A firm varies the quantities of the different factors of production in such a view that it gets equal marginal returns from all the lines of expenditure for factors.
The condition for the least-cost combination or the optimum combination of factors in equilibrium is expressed in the following manner:
A firm would employ more of one factor and less of the other till the above “proportionately rule” is satisfied.
The above result can be extended to cover any number of variable factors.
In a more general situation, the condition for the least-cost combination may be expressed as follows:
MPa/Pa = MPb/Pb = ….. = MPn/Pn
where MPa is the marginal product of factor A and Pa is the price of A, and so on. If MPa/Pa is greater than it will be to the advantage of the entrepreneur to employ more of factor A and less of factor B. He will employ more of one factor and less of the other till the above rule or the law of equi-marginal return is satisfied.
Conclusion:
The principle of least-cost combination or the law of equimarginal return plays a very important role in the theory of production. This rule is used by a profit-maximising firm to make an optimum purchase of variable factors the prices of which are taken as given.
The principle suggests that the choice of an efficient combination of variable factors depends on two things, viz., the marginal productivity of different factors and their prices. Only by making a comparison between factor prices and productivity it is possible to choose an optimum combination of resources.