March 13, 2018

Law of Diminishing Returns - Increasing Cost

March 13, 2018

The law of diminishing returns is very old and fundamental principle of economics. It plays an essential role in production theory. According to the law, when variable factors of production are successively increased while keeping one or two other factors constant, then after a point the marginal output will begin to decline. For example, adding more and more workers to a job will increase total output but diminish marginal output after a certain point.

Law of Diminishing Returns (Explanation)

The law of diminishing returns can be explained with the help of a schedule and a diagram.

The above table shows when the employer applies 1 unit of variable factor (labor and capital) while keeping the units of machine constant, he gets 600 production of bottles. When he increased the unit of variable factor from 1 to 2, his production increased from 600 to 700 bottles. We can see the marginal output is increasing till third unit of variable factor. After third unit of variable factor is employed, the marginal output goes on declining. This declining of marginal output after third unit is showing the law of diminishing returns.

The law of diminishing returns can further be illustrated by using an imaginary diagram.

Units of variable factors of production (capital and labor) on X-axis and units of marginal output on Y-axis have been measured in the above diagram (2.3). We can see the marginal output is increasing till second unit of variable factor. After the second unit of variable factor, the marginal output begins to decline which is representing the law of diminishing returns.

Assumptions of The Law

The law of diminishing returns is based on the following assumptions:

1. Technique of production must remain constant.

2. The law is applicable in short run. It will not work in long run, because in long run all factors of production become variable.

3. All the units of variable factors should be similar to each other and are equally efficient.

4. At least one factor of production must be kept fixed.

Law of Increasing Cost

As marginal output is declining with the successive use of variable factors, the marginal cost is rising. Therefore, the law of diminishing returns is also known as the law of increasing cost.  The given below table is illustrating the law of increasing cost.

The above table shows as the units of labor is applied successively while keeping the units of machine constant at 7, the marginal output of bottle is declining and the marginal cost per bottle is rising which is representing the law of increasing cost.
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