First year intermediate - Principle of Economics - Chapter 8

Laws of Returns

Law of Diminishing Returns

Introduction

In some cases the return due to each successive additional unit, the production goes on diminishing. It is known as Diminishing Returns and is further explained by the Law of Diminishing Returns.

Explanation

This law is one of the most fundamental law of Economics. Usually it is related with agriculture and was also first enumerated by a Scottish Farmer.

Usually an increase in any of the factor of production results in an increase in production but this change is a proportionate change. It means that if the quantity of land and labour is doubled, although there will be an increase in the production but it will not be doubled. And that is what Law of Diminishing Returns states. In the words of Marshall:

“An increase in the capital and labour applies in the cultivation of land causes in general a less than proportionate change or increase in the amount of production raised. Unless it happens to coincide with an improvement in the art of agriculture.”

Law of Increasing Returns

Introduction

In order to increase the production, a producer has to increase the proportion of its fraction of production. However, the returns due to variations in the factors are not fixed. In some cases, return due to each successive unit is increased. This tendency is known as Law of Increasing Returns.

Explanation

This law is mostly found to be operating in manufacturing industries. This law was first propounded by Prof. Marshall, in his words, the law states that:

“An increase of labour and capital leads generally to improved organization, which increases the efficiency of the work of labour and capital.”

According to this law whenever a new dose of labour and capital is applied it yields increasing returns. Also the cost of production diminishes.

Law of Constant Returns

Introduction

Similarly, in some of the cases, the increase in the productive unit keeps the production constant. This tendency is known as law of Constant Returns.

Explanation

When an increase or decrease in the output of an industry makes not alteration in the cost of production per unit, the law of constant returns is said to operate. In other words when fresh doses of productive resources results in an equal return, it is called constant returns.

The law of constant returns operates in those industries where the cost of raw material and manufacturing cost are half and half. In other words the law operates where man and nature dominate equally. It is also said that a point where the opposite tendencies of diminishing returns and increasing returns are in equilibrium is the Constant Returns.

Examples

Possible examples of industries where the law applies are cane growing and sugar making, Iron-ore mining and steel making, cane growing and iron ore are subject to law of diminishing turns whereas sugar making and steel making to law of increasing turns. In these industries the advantage of increasing returns are neutralized by increasing cost of raw materials.

Why does Law of Diminishing Returns apply to Agriculture?

The law of diminishing returns specially applies to agriculture and other extractive industries. One thing that is common to all these industries is the supremacy of nature. It is therefore often remarked that the part that nature plays in production corresponds to diminishing returns and the part which man plays confirms to the law of increasing returns. The reason is that, nature where it is supreme is subject to diminishing returns, while industry where man is supreme is subject to increasing return. Besides the supremacy of nature, there are several other reasons why agriculture is subject to the law of diminishing returns. The agricultural operations are spread out over a wide area, and supervision cannot be very effective. Scope for the use of specialized machinery is also very limited. Therefore economics of large scale production cannot be reaped.

Does it apply only to Agriculture?

It is wrong to say that the law only applies to agriculture as agriculture is always subject to diminishing and manufacturing to increasing returns. The application of the law is universal. It applies to industries also. If the industry is expanded too much and becomes unwisely supervision will become tax and the cost will go up. The law of diminishing returns thus sets in. The only difference is that in agriculture it sets in earlier and in industry much later.