LAW OF DIMINISHING RETURNS
Diminishing returns, also called law of diminishing returns or principle of diminishing marginal productivity, is an economic law stating that if one input in the production of a commodity is increased while all other inputs are held fixed, a point will eventually be reached at which additions of the input yield progressively smaller, or diminishing, increases in output.
The law of diminishing returns is also known as law of increasing costs.
Law of diminishing returns explains that when more and more units of a variable input are employed on a given quantity of fixed inputs, the total output may initially increase at increasing rate and then at a constant rate, but it will eventually increase at diminishing rates.
In other words, the total output initially increases with an increase in variable input at given quantity of fixed inputs, but it starts decreasing after a point of time.
ACCORDING TO G. STIGLER
“As equal increments of one input are added; the inputs of other productive services being held, constant, beyond a certain point the resulting increments of product will decrease, i.e., the marginal product will diminish.”
ACCORDING TO ALFRED MARSHALL
“An increase in the Capital and Labour applied in the cultivation of land causes, in general, less than proportionate increase in the amount of produce raised unless it happens to coincide with an improvement in the art of agriculture.”
ACCORDING TO F. BENHAM
“As the proportion of one factor in a combination of factors is increased, after a point, first the marginal and then the average product of that factor will diminish.”
ACCORDING TO SILVERMAN
“After a certain point, an increase in the capital and labour applied in proportion, causes a less than proportionate increase in the amount of the product.”
ACCORDING TO MRS. JOAN ROBINSON
“Law of Diminishing Return states that if any one means is static then the rate of quantity of other means will increase in a reducing rate.”
ASSUMPTIONS OF LAW OF DIMINISHING RETURNS
The assumptions of the law of diminishing returns are as follows:
NO CHANGE IN TECHNOLOGY
First of all, the law is based on the assumption that there is no change in the techniques of production. If the techniques of production undergo a change, in that case the efficiency of production would increase. Therefore, this law applies only if there is no change in the method of technology.
The law is applicable in the short run as supply of one or the other factor cannot be increased within the short span of time. Thus, they are considered fixed.
THE QUANTITY OF LAND SHOULD BE CONSTANT AND FIXED:
This law will operate when the quantity of land is kept fixed and then other means like Labour and Capital’s quantity is increased. If this has not been followed then instead of diminishing return the law of increasing return will operate.
MEASUREMENT OF PRODUCT
The output is measured in physical units like tones, kilograms etc.
THIS LAW IS CONCERNED WITH MARGINAL PRODUCTION AND NOT WITH TOTAL PRODUCTION
For operation of this law, we have to see and observe marginal quantity of production and not the total quantity of production.
THIS LAW IS CONCERNED WITH THE PHYSICAL QUANTITY OF THE PRODUCTION AND NOT WITH ITS PRICE
Under this law quantity of production is kept into consideration and not the price. Because in Diminishing Return when production will go down the price may increase and the goods which are available may fetch higher price.
EXPLANATION OF THE LAW OF DIMINISHING RETURNS
The law of diminishing returns can be explained in two forms:
- Law of Diminishing Returns
This can be explained as follows:
It is seen from the table that the producer is employing different units of labour and capital in the cultivation of land. Here production is increasing at a diminishing rate with every increase in the unit of labour and capital on the fixed piece of land, i.e., two hectares and marginal and average production is diminishing. The marginal production of the next labourer is 3 quintals, 2 quintals and 1 quintal respectively. The law of diminishing returns can be explained with the help of a figure. In figure, units of labour and capital are given on OX-axis whereas marginal product is shown along OY axis.
In this figure, Marginal Product slopes downward. This curve indicates that as more units of labour and capital are employed, every new unit is producing less marginal production than the preceding one. The marginal product in every successive unit declines to 3, 2 and 1 respectively. Thus curve DR indicates the diminishing marginal returns.
- Law of Increasing Costs
The law can also be explained in terms of average cost. When use of more units of labour and capital is accompanied by diminishing returns, then there is a tendency for the average cost of production to increase. That is why this law is called law of Increasing Costs. The fact is clearer in table 3 and Figure 3.
The above table is based on the assumption that land is fixed factor of production and total cost of one unit of labour is Rs. 40.00. At every successive unit, total cost increases at the same time. Thus, at first unit of labour, the average cost of production comes to Rs. 8 per quintal.
With the use of second, third and fourth units of labour and capital, it increases to Rs. 10, Rs. 12 and Rs. 14.5 respectively.
In the diagram, units of labour and capital are shown on OX-axis and average cost on OY-axis. At every successive unit, average cost increases from 8 to 10, 12 and 14.5. Therefore, upward slope of IC curve reflects increasing cost.
CAUSES OF OPERATION OF LAW OF DIMINISHING RETURNS
1. Prominence of Nature in Agriculture and Primary Industries:
Dr. Marshall has pointed out that the part which nature plays conforms to diminishing returns and the part which man play brings in increasing return. It has been said by economist that nature is supreme in agriculture, where-as man dominates in manufacturing industries.
2. Fixed Supply of the Factors:
Supply of some means are fixed, therefore, this rule applies. For example—The supply of land is fixed and if more of labour and capital is introduced in the same land the Law of Diminishing Return is bound to operate.
3. Misuse or Improper Use of the Factors of Production:
Economists are of this opinion that proper and optimum use of the factors of production should be made. If proper use has not been made then the law will operate.
4. Lack of Perfect Substitutability between Factors:
In this all means of production are not perfect substitutes to each other. Therefore, by increasing one factor the loss of another factor cannot be completed. For example—By increasing the supply of labour, the shortage of land cannot be met, therefore, the Law of Diminishing return is bound to operate.
5. Dis-economies in Production:
If the production is increased without considering its effects, then there will be dis-economies and the Law of Diminishing Return will start operation.
APPLICATION OF THE LAW OF DIMINISHING RETURNS IN DIFFERENT FIELDS
The Law of Diminishing Marginal Return does not apply in agriculture alone. Prof. Marshall says that this law is limited to agriculture only but actually this is not the case. In the present age this law has become a general law and is applicable to other industries also besides agriculture.
1. In Mining Industries:
Law of Diminishing Return is applicable in mining industries also. The amount of materials in the mine is limited. In mining industries as more labour and capital is applied, so the level of depth has to be increased. As the depth increases the expense and difficulties start increasing. As more labour and capital is applied the marginal utility of mine goes on decreasing.
2. In Fisheries:
This law is applicable in fishing also. Limited area is the chief reasons of it. In fishing as more labour and capital is increased the marginal utility goes on decreasing. The reason is that the quantity of fishes goes on decreasing day by day.
3. In House Building Industry:
The Law of Diminishing Return is also applicable in house-building industry. This law is applicable specially in the Case of multi-Storeyed building. As labour and capital is applied for building the materials has to be carried higher and higher. The proportion of utility ascertained is not equal to the proportion of labour and capital used.
4. In Forest Industry:
The law also applies in forest industry, first the wood of nearer place is taken and cutting goes on but as the wood of nearer place in exhausted, going to deep forest for wood would involve more expense and thus the Law of Diminishing Return starts operation.
5. In Manufacturing Industries:
Prof. Marshall’s concept is that this law is not applied with regard to manufacturing industries. According to Marshall in these industries several internal and external benefits are required due to scientific inventions, division of labour and use of machines. So the cost of production decreases and marginal utility increases instead of decreasing.
Modern economists do not agree with the Marshallian view. They are of this opinion that this law is applicable in manufacturing industries also. The difference is that in agriculture this law applies more quickly as compared to that of manufacturing industries. So it is clear that in manufacturing industries also as labour and capital is increased the marginal utility goes on decreasing after a certain limit.
6. In Intensive and Extensive Cultivation:
The Law of Diminishing Return operates in both intensive and extensive cultivation. If more and more labour and capital are applied to the same piece of land, the return per dose diminishes after some time. Thus, the law applies to intensive cultivation. But if on the other hand the farmer brings more and more land under cultivation even then the returns will decrease.
It is because, either the new land is inferior (otherwise, it would have been cultivated first) or because it, is at a distance and in which the cost of transport increases the cost of production. Thus, the Law of Diminishing returns also applies where cultivation is carried on extensively.
WHY THE LAW APPLIES TO AGRICULTURE?
The law of diminishing returns has a vast application, but it specially applies in agriculture sector. The most important factors responsible due to which the law is applicable in agriculture are undernoted:
1. Limited Land:
The most important factor due to which this law applies to agriculture is the limited size of land. Production is sought to be increased by employing more and more units of variable factors. This will result in diminishing returns.
2. Less Use of Machinery:
In the agricultural sector, there is limited use of machinery as compared to industry. The reason is that in the agricultural sector most of the work is done by hands. This also results in low productivity. Thus, agriculture remains deprived of several external and internal economies of scale. Therefore, the law of diminishing returns applies in agricultural sector.
3. Natural Factors:
Another reason due to which the law of diminishing returns applies is the natural influence like rainfall, climate, floods etc. Even, in case man makes all best efforts but nature is not in favour, the law of diminishing returns is surely to apply.
4. Seasonal Occupation:
Agriculture is a seasonal occupation. The people are not busy on land throughout the year. They remain busy only during the period of ploughing and harvesting season. This period is approximately of six months. For the remaining period, both farmers and cattle remain idle which reduce the production per worker. It is, thus, the law of diminishing returns quickly applies to agriculture sector.
5. Difference in the Fertility of Land:
All pieces of land are not equally fertile. When demand for land increases even less fertile land are also brought under cultivation. It means less marginal returns and high cost of production.
6. Ineffective Supervision:
Agricultural operations are spread over the vast areas. Therefore, effective supervision becomes most risky and difficult. The result is the law of diminishing returns.
7. Less Chances of Division of Labour:
In agricultural sector, there are very less chances of division of labour. Therefore, production on large scale is ruled out. It also results into the operation of the law of diminishing returns.
IMPORTANCE OF LAW OF DIMINISHING RETURNS
The law of diminishing returns is universal which applies everywhere. Marshall was of the view that this law is applicable in every branch of industry or even in all human affairs. It is the basis of all laws.
The importance of the law is given below:
1. Theory of Population:
Malthusian theory of population is based on the law of diminishing returns. According to Malthusian theory, production of food grains does not increase in the same proportion in which population increases. In other words, production of food grains increases in arithmetical ratio (1, 2, 3, 4, 5,) whereas population increases in geometrical ratio (2, 4, 8, 16, 32, 64…). The reason is that agriculture obeys the law of diminishing returns.
2. Basis of the Theory of Production:
The law of diminishing returns helps the producer to calculate the optimum production. In simple terms, this law signifies whether the optimum level of production in any field has reached or not.
3. Basis of Innovation:
Basically, every producer wants to postpone the law. It is only possible when the new methods of production, new tools, raw materials etc are innovated. All these factors put a check on the operation of the law of diminishing returns.
4. Basis of the Theory of Rent:
Ricardian theory of rent is also based on this very law. According to Ricardian theory, rent Arises due to difference in fertility. First dose of labour and capital applied to land yields more return as compared to second dose. The difference between first and second dose is called the rent. It means:
Rent = Produce from first dose – Produce from second dose.
5. Basis of the Theory of Distribution:
Marginal productivity theory of distribution is also based on the law of diminishing returns. According to this theory, as the producer employs more and more factors of production, the marginal productivity of each factor of production goes on falling. Thus, we can conclude that this law is the basis of the theory of distribution.
6. Importance to Industry:
The manufacturing industry has a great significance of the law of diminishing returns. Every manufacturing industry has a higher per capita income as compared to agricultural sector. The reason is that this law operates at a very early stage in the agricultural sector and the per capita income remains low. But in the manufacturing industry, the operation of this law can be prevented for a very long period. This is the reason; it is called universal as it applies everywhere and anywhere. According to Wicksteed, “This law is as universal as the law of life itself’.
LIMITATIONS OF THE LAW OF DIMINISHING RETURNS
Marshall has explained the law in general terms which is subject to criticism. This means that the law is not applicable in all cases.
The limitations of the law are discussed as under:
1. New Soil:
The law of diminishing returns does not hold well in case of new soil i.e., when the land is cultivated for the first time. Certainly in such cases, production will be higher initially.
2. Improved Methods of Cultivation:
In modern times, when there are improved methods of cultivation, this law is not applicable. The improved methods of production are cropping pattern, new seeds, and fertilizer, mechanization and irrigation facilities. When these methods are used, there are good chances of more production. Thus, there are chances of increasing returns even in agriculture sector.
3. Shortage of Capital:
The law of diminishing returns does not apply in case of shortage of capital or insufficiency of capital. If, we have ample stock of capital, the law of increasing returns would operate and not the law of diminishing returns. These factors can check the operation of the law of diminishing returns temporarily. But this law is bound to apply ultimately. These can be delayed in the application of the law but the law is definite to apply sooner or later.