Final answer:
The three stages of production are Stage I with increasing returns, Stage II with diminishing returns but increased total production, and Stage III with negative returns. Firms generally operate in the latter part of Stage I and throughout Stage II to maintain efficiency and profitability.
Step-by-step explanation:
The relationship between Total Product (TP), Marginal Product (MP), and Average Product (AP) is fundamental to understanding the three stages of production within the short run production function. These relationships help delineate the response of output to varying levels of a variable input, typically labor.
Stage I: Increasing Returns to the Variable Input
In Stage I, both MP and AP are rising as more of the variable input is employed. This results from increased specialization and efficiencies. However, MP peaks and starts to decline before AP does. Despite the decline in MP, it remains above AP, and both TP and AP continue to increase. Firms aim to operate in the latter part of this stage since it is the most efficient point before diminishing returns set in.
Stage II: Diminishing Returns to the Variable Input
Stage II is marked by the point after MP has reached its maximum and begins to decrease. AP also starts to decline, but both MP and AP are positive, which means TP is still increasing, but at a decreasing rate. The end of Stage II is recognized when MP drops to zero, which is the point of maximum TP. Businesses typically operate in this stage because it includes the point where AP is at its peak, often regarded as the most efficient level of production.
Stage III: Negative Returns to the Variable Input
In Stage III, MP becomes negative, signaling that adding more of the input actually decreases total output (TP). AP is also in decline. This stage illustrates the excessive application of the variable input leading to overcrowding and inefficiencies. Firms avoid operating in this stage as it results in reduced productivity and profitability.
To visualize these stages, a graph displaying TP, MP, and AP curves is used. The 'law of diminishing returns' is visibly demonstrated as the input is increased. In practice, firms aim to stay in the early or mid-portions of Stage II, where the production process is the most efficient.