Law of Diminishing Returns/Law
of Increasing Cost:
(Version of Classical and Neo
Classical Economists):
Definition:
The law of diminishing returns
(also called the Law of Increasing Costs) is an important
law of micro economics. The law of diminishing returns
states that:
"If an increasing amounts of a variable factor are
applied to a fixed quantity of other factors per unit of time,
the increments in total output will first increase but beyond
some point, it begins to decline".
Richard A. Bilas describes the
law of diminishing returns in the following words:
"If the input
of one resource to other resources are held constant, total
product (output) will increase but beyond some point, the
resulting output increases will become smaller and smaller".
The
law of diminishing return can be studied from two points of
view, (i) as it applies to agriculture and (ii) as it
applies in the field of industry.
(1)
Operation of Law of Diminishing Returns in Agriculture:
Traditional Point of View.
The classical economists were of the opinion that the taw of
diminishing returns applies only to agriculture and to some
extractive industries, such as mining, fisheries urban land,
etc. The law was first stated by a Scottish farmer as such. It
is the practical experience of every farmer that if he wishes to
raise a large quantity of food or other raw material
requirements of the world from a particular piece of land, he
cannot do so. He knows it fully that the producing capacity of
the soil is limited and is subject to exhaustation.
As he
applies more and more units of labor to a given piece of land,
the total produce no doubt increases but it increases at a
diminishing rate.
For example, if the number of
labor is doubled, the total yield of his land will not be
double. It will be less than double. If it becomes possible to
increase the. yield in the very same ratio in which the units of
labor are increased, then the raw material requirements of
the whole world can be met by intensive cultivation in a single
flower-pot. As this is not possible, so a rational farmer
increases the application of the units of labor on a piece of
land up to a point which is most profitable to him. This is in
brief, is the law of diminishing returns. Marshall has
stated this law as such:
"As Increase in capital and labor
applied to the cultivation of land causes in general a less than
proportionate increase in the amount of the produce raised,
unless it happens to coincide with the improvement in the act of
agriculture".
Explanation
and Example:
This law can be made more clear if
we explain it with the help, of a schedule and a curve.
Schedule:
|
Fixed Input |
Inputs of Variable Resources |
Total Produce TP (in tons) |
Marginal product MP (in
tons) |
|
12 Acres
12 Acres
12 Acers
12 Acres
12 Acers
12 Acres |
1 Labor
2 Labor
3 Labor
4 Labor
5 Labor
6 Labor |
50
120
180
200
200
195 |
50
70
60
20
0
-5 |
In the schedule given above, a firm
first cultivates 12 acres of land (Fixed input) by applying one
unit of labor and produces 50 tons of wheat.. When it applies 2
units of labor, the total produce increases to 120 tons of
wheat, here, the total output increased to more than double by
doubling the units of labor. It is because the piece of land is
under-cultivated. Had he applied two units of labor in the very
beginning, the marginal return would have diminished by the
application of second unit of labor.
In our schedules the rate
of return is at its maximum when two units of labor are applied.
When a third unit of labor is employed, the marginal return
comes down to 60 tons of wheat With the application of 4th
unit. the marginal return goes down to 20 tons of wheat and when
5th unit is applied it makes no addition to the total
output. The sixth unit decreased it. This tendency of marginal
returns to diminish as successive units of a variable resource
(labor) are added to a fixed resource (land), is called the law
of diminishing returns. The above schedule can be represented
graphically as follows:
Diagram/Graph:
In Fig. (11.2) along OX are measured doses of labor applied to a
piece of land and along OY, the marginal return. In the
beginning the land was not adequately cultivated, so the
additional product of the second unit increased more than of
first. When 2 units of labor were applied, the total yield was
the highest and so was the marginal return. When the number of
workers is increased from 2 to 3 and more. the MP begins to
decrease. As fifth unit of labor was applied, the marginal
return fell down to zero and then it decreased to 5 tons.
Assumptions:
The table and the diagram is based
on the following assumptions:
(i) The time is too short for a firm
to change the quantity of fixed factors.
(ii) It is assumed that labor is the
only variable factor. As output increases, there occurs no
change in the factor prices.
(iii) All the units of the variable
factor are equally efficient.
(iv) There are no changes in the
techniques of production.
(2)
Operation of the Law in the Field of Industry:
The modern economists are of the
opinion that the law of diminishing returns is not exclusively
confined to agricultural sector, but it has a much wider application.
They are of the view that whenever the supply of any essential
factor of production cannot be increased or substituted
proportionately with the other sectors, the return per unit of
variable factor begins to decline. The law of diminishing
returns is therefore, also called the Law of Variable
Proportions.
In agriculture, the law of diminishing returns
sets in at an early stage because one very important factor,
i.e., land is a constant factor there and it cannot be increased
in right proportion with other variable factors, i.e., labor and
capital. In industries, the various factors of production can be
co-operated, up to a certain point. So the additional return per
unit of labor and capital applied goes on increasing till there
takes place a dearth of necessary agents of production. From
this, we conclude that the law of diminishing return arises from
disproportionate or defective combination of the various agents
of production. Or we can any that when increasing amounts of a
variable factor are applied to fixed quantities of other
factors, the output per unit of the variable factor eventually
decreases.
Mrs. John Robinson goes deeper into
the causes of diminishing returns and says that:
"If all factors
of production become perfect substitute for one another, then
the law of diminishing returns will not operate at any stage".
For instance, if sugarcane
runs short of demand and some other raw material takes its place
as its perfect substitute, then the elasticity of substitution
between sugarcane and the other raw material will be infinite.
The price of sugarcane will not rise and so the law of
diminishing returns will not operate.
The law of diminishing returns,
therefore, in due to Imperfect substitutability of factors of
production.
The law of diminishing returns is
also called as the Law of Increasing Cost. This is because of
the fact that as one applies successive units of a variable
factor to fixed factor, the marginal returns begin to diminish.
With the cost of each variable factor remaining unchanged by
assumptions and the marginal returns registering .decline, the
cost per unit in general goes on increasing. This tendency of
the cost per unit to rise as successive units of a variable
factor are added to a given quantity of a fixed factor is called
the law of Increasing Cost.
Importance:
The law of diminishing returns
occupies an important place in economic theory. The British
classical economists particularly Malthus, and Ricardo
propounded various economic theories, on its basis. Malthus, the
pessimist economist, has based his famous theory of Population
on this law.
The Ricardian theory of rent is also based on the
law of diminishing return. The classical economists considered
the law as the inexorable law of nature.
Relevant Articles:
|
