Law of Costs:

Definition and Explanation:

Law of Costs is also known as laws of returns. As an industry is expanded with the increased investment of resources, the marginal cost (i.e., the amount which is added to the total cost when the output is increased by one unit) decreases in some cases, increases in others and in some, it remains the same. This tendency on the part of the marginal cost to fall, rise or to remain the same as output is expanded, is described in economics as the law of diminishing costs, the law of increasing costs, and the law of constant costs.

If we know the money cost of a unit of a factor invested in a particular industry, then the marginal cost can be derived easily dividing the money cost of a unit of factor by its marginal return.

The following table will make clear as to how the marginal cost decreases with the increases in marginal returns, rises with the fall in marginal returns and remains constant with the marginal return remaining the same. Let us suppose that the cost of each unit of factor applied is worth $100 only.

Schedule:

Units of  Factor	Total Return (meters of Cloth)	Marginal Return (meters)	Marginal Cost (in Dollars) (per meter)
1	10	10	10
2	30	20	5
3	55	25	4
4	88	33	3
5	138	50	2
6	238	100	1
7	338	100	1
8	400	62	1
9	450	50	2
10	475	25	4
11	490	15	6

In the schedule given above, the taw of diminishing costs operates up to the 6th unit, between the 6th and 7th units, it is the law of constant costs which prevails and from 7th unit onward, it is the law of increasing costs which sets in.

Diagram/Graph:

In the Fig. (11.5) units of factors are measured along OX axis and marginal cost along OY axis. The  failing curve MN represents the operation of law of diminishing costs. NP shows constant costs, and PC indicates the increasing cost. MC is the marginal cost curve.