Law of Increasing Returns/Law of Diminishing Cost:

(Version of Classical and Neo Classical Economists):

Definition and Explanation:

The law of increasing returns is also called the law of diminishing costs. The law of increasing return states that:

"When more and more units of a variable factor is employed, while other factor remain fixed, there is an increase of production at a higher rate. The tendency of the marginal return to rise per unit of variable factors employed in fixed amounts of other factors by a firm is called the law of increasing return".

An increase of variable factor, holding constant the quantity of other factors, leads generally to improved organization. The output increases at a rate higher than the rate of increase in the employment of variable factor.

The increase in output faster than inputs continues so long as there is not deficiency of an essential factor in the process of production. As soon as there occurs shortage or a wrong or defective combination in productive process, the marginal product begins to decline. The law of diminishing return begins to operate. We can, therefore, say that there are no separate laws applicable to agriculture and to industries. It is only the law of variable proportions which applies to a!! the different industries. However, the duration of stages in each productive undertaking will vary. They will depend upon the availability of resources, their combination in right proportions, etc., etc.

Application of the Law of Increasing Returns in Industries:

There are certain manufacturing industries where the factors of production can be combined and substituted up to a certain limit, it is the law of increasing returns which operates. In the words of Prof. Chapman:

"The expansion of an industry in which there is no dearth of necessary agents of production tends to be accompanied, other things being equal, by increasing returns".

The increasing returns mainly arises from the fact that large scale production is able to secure certain economies of production, both internal and external. When an industry is expanded, it reaps advantages of division of labor, specialized machinery, commercial advantages, buying and selling wholesale, economies in overhead expenses, utilization of by products, use of extensive publicity and advertisement, availability of cheap credit, etc.. etc.

The law of increasing returns also operates so long as a factor consists of large indivisible units and the plant is producing below its capacity. In that case, every additional investment will result in the increase of marginal productivity and so in lowering the cost of production of the commodity produced. The increase in the marginal productivity continues till the plant begins to produce to its full capacity.

  

Assumptions:

The law rests upon the following assumptions:

(i) There is a scope in the improvement of technique of production.

(ii) At least one factor of production is assumed to be indivisible.

(iii) Some factors are supposed to be divisible. 

Example:

    

The law of increasing returns can also be explained with the help of a schedule and a curve.

Schedule:

Inputs	Total Returns (meters of cloth)	Marginal Returns (meters of cloth)
1	100	100
2	250	150
3	450	200
4	750	300
5	1200	450
6	1850	650
7	2455	605
8	3045	600

In the above table it is dear that as the manufacturer goes on expanding his business by investing successive units of inputs, the marginal return goes on increasing up to the 6th unit and then it beings to decline steadily, Here, a question ca be asked as to why the law of diminishing returns has operated in an industry?

The answer is very simple. The marginal returns has diminished after the sixth unit because of the non-availability of a factor or factors of production or. the size of the business has become so large that it has become unwieldy to manage it, or the plant is producing to its full capacity and it is not possible further to reap the economies of large scale production, etc., etc.

Diagram/Graph:

In figure 11.3, along OX axis are measured the units of inputs applied and along OY axis the marginal return is represented. PF is the curve representing the law of increasing returns.

Compatibility of Diminishing and Increasing Returns:

It is often pointed out by the classical economists that the law of diminishing returns is exclusively confined to agriculture and other extractive industries, such as mining fisheries, etc. while manufacturing industries obey the law of increasing returns. In the words of Marshall:

"While the part which Nature plays in production shows a tendency to diminishing returns and the part which man plays shows a tendency to increasing returns".

The modern economists differ with this view and are of the opinion that the law of diminishing returns applies both to agriculture and the industry. The only difference is that in agriculture the law of diminishing returns begins to operate at an early stage and in an industry somewhere at a later stage.

The law of increasing returns is also named as the Law of Diminishing Cost. When the addition to output becomes larger, as the firm adds successive units of a variable input to some fixed inputs, the per unit cost begins to decline. The tendency of the cost per unit to decline with increased application of a variable factor to fixed factors is called the Law of Diminishing Cost.