Law of Retrun

By Arti Singla (2910087)
LAW OF RETURN: 

Introduciton

The law of variable proportions has three different phase.

      I.            -Increasing return to a factor.

  II.            -Constant returns to a factor.

III.            -Diminishing return to a factor.

Ø The Law of Increasing Returns

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.

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..

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.

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

Schedule: 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:

Ø Law of Constant Returns/Law of Constant Cost:

Definition and Explanation:

The law of constant returns also called law of constant cost. It is said to operate when with the addition of successive units of one factor to fixed amount of other factors, there arises a proportionate increase in total output. The yield of equal return on the successive doses of inputs may occur for a very short period in the process of production. The law of constant return may prevail in those industries which represent a combination of manufacturing as well as extractive industries.

On the side of manufacturing industries, every increased investment of labor and capital may result in a more than proportionate increase in the total output. While on the other extractive side, an increase in investment may cause, in general, a less than proportionate increase in the amount of produce raised. If the tendency of the marginal return to increase is just balanced by the tendency of the marginal return to diminish yielding an equal return, we have the operation of the law of constant returns. In the words of Marshall:

"If the actions of the law of increasing and diminishing returns are balanced, we have the law of constant return".

In actual life, the law of constant returns can operate only if the following conditions are fulfilled:

(i) There should not be any increase in the prices of raw materials in the industry. This can only be possible if commodities are available in large supply.

(ii) The prices of various factors of production should remain the same. The .supply of various factors of production needed for a particular industry should be perfectly elastic.

(iii) The productive services should not be fixed and indivisible.

If we study the above mentioned conditions carefully, we will easily conclude that in the actual world, it is not possible to find an industry which obeys the law of constant returns. The law of constant returns can operate for a very short period when the marginal return moves towards the optimum point and begins to decline. If the marginal return, at the optimum level remains the same with the increased application of inputs for a short while, then we have the operation of law of constant returns. The law is represented now in the form of a table and a curve.

Schedule:

Productive doses Total Return (meters of cloth) Marginal Return (meters of cloth) 1 60 60 2 120 60 3 180 60 4 240 60 5 300 60

In the table given above, the marginal return remains the same, i.e. 60 meters of cloth with the increased investment of inputs.

Diagram/Graph:

In figure (11.4) along OX are measured the productive resources and along OY is represented the marginal return. CR is the fine representing the law of constant returns. It is parallel to the base axis.

Ø The Law Of Diminishing Marginal Returns

·         Total Product (TP) This is the total output produced by workers

·         Marginal Product (MP) This is the output produced by an extra worker

Definition: Law of Diminishing Marginal Returns

· Diminishing Returns occurs in the short run when one factor is fixed (e.g. Capital)

· If the variable factor of production is increased, there comes a point where it will become less productive and therefore there will eventually be a decreasing marginal and then average product

· This is because if capital is fixed extra workers will eventually get in each other’s way as they attempt to increase production. E.g. think about the effectiveness of extra workers in a small café. If more workers are employed production could increase but more and more slowly.

· This law only applies in the short run because in the long run all factors are variable.

· Assume the wage rate is £10, then an extra worker Costs £10.

· The Marginal Cost (MC) of a sandwich will be the Cost of the worker divided by the number of extra sandwiches that are produced

· Therefore as MP increases MC declines and vice versa

· A good example of Diminishing Returns includes the use of chemical fertilizers- a small quantity leads to a big increase in output. However, increasing its use further may lead to declining Marginal Product (MP) as the efficacy of the chemical declines.

Diagram of Diminishing Returns