LAW OF DIMINISHING MARGINAL RETURN

The law of diminishing returns is one of the very old

laws in economics.
It is the practical experience of every farmer that
“successive applications of labour and capital to a
given area of land must ultimately, other things
remaining the same, yield a less than proportionate
increase in production”. It is the base of many
economic theories.
Classical economists like Ricardo, Malthus, Marshall
were of the opinion that the law is applicable in the
field of agriculture.
 …

Sir Edward West was the first to explain this law. He

stated the law thus: “ Each additional quantity of work
bestowed on agriculture yields an actually diminishing
return.”
Marshall states:
“ An increase in the amount of capital and labour
applied in the cultivation of land causes in general a less
than proportionate increase in the amount of produce
raised unless it happens to coincide with an
improvement in the art of agriculture.”
 Contd..

Mrs. John Robins says, “ The law of

diminishing returns states that with a fixed
amount of any one factor of production,
successive increases in the amount of other
factors will after a point, yield a diminishing
increment of the product.”
 Assumptions
Change in the factor proportions: The law assumes
the proportions in which the factors of production are
put to use to be changeable. It is possible to change the
ratio of the variable factor to the fixed factor of
production.
Short Run: The law is based on the assumption of
short run because the distinction between fixed and
variable factors is possible under short run.
Homogeneous factors: it is assumed that the different
units of a variable factor of production are
homogeneous in quality and quantity.
No change in price : The law can be stated in terms of
costs only if the prices of variable inputs as well as the
prices of out remain constant
 Contd………

No change in techniques of production: the law

rests on the assumption that the techniques of
production do not change.
Explanation of the Law
Let us assume that the farmer has a certain amount
of labour and capital as a dose of the variable
factors to be employed on the fixed factor land. As a
result of the increased number of doses employed
on land, the total production shall increase, but the
increments to the total production shall go on
diminishing with the every dose . It is shown in the
table
 Contd..

Units of land Doses of labour and Total product Marginal product

(fixed factor) capital ( variable (Quintals) (Quintals)
Factor)
5 acres 1 12 12

5 acres 2 16 4

5 acres 3 19 3

5 acres 4 21 2

5 acres 5 22 1
 Contd..

According to this law, as we increase the number of

variable factors in relation to the fixed factors of
production, marginal return goes on decreasing. The law of
diminishing returns operates due to the following reasons:
Fixity of some factors: For farmers, land is a fixed factor.
When other factors are mixed with this factor in increasing
proportions, this fixed factor is spread thinly with the units
of the variable factor.
Optimum proportion of factors: In many production
processes factors are to be combined in a proportion which
is the given best proportion. If this proportion is disturbed,
the efficiency of factors’ use falls leading to diminishing
returns.
 Contd….

Imperfect substitutes: the factors of

production are imperfect substitutes for one
another. The greater the imperfection in
substitutes of one factor for another, the
faster shall the marginal return fall as the
ratio of one factor is changed relatively to
the other.
Limitations or exceptions of the law
This law is universal law. It is a law which
has the most widespread application. Even
then it has the following limitations.
 Contd…

Newly cultivated land: This law does not apply to lands

which are cultivated for the first time.
Inadequate application of labour and capital: where
labour and capital are in less than the optimal proportion
to land, the productivity of labour and capital may
increase at first for very short time period.
Improvement in the area of agriculture: this law does
not apply where the technology of agriculture itself is
changed.
 IMPORTANCE OF THE LAW

1. Malthus based his theory of population on the

operation of this law on food production.
2. David Ricardo used this law to explain his theory of
rent.
3. This law can be used to estimate the optimum
proportion of the factors of the production.
4. This law helps us in explaining the presence of
disguised unemployment.
5. This law is used to explain the long term tendency of
the developed economies to stagnation.
 Increasing Returns
The Law of Increasing Returns was propounded in the
seventeenth century. This law is nothing but an
improvement over the law of diminishing returns.
According to this law, “Production of a commodity
increases in a larger proportion as compared to the
increase in the units of factors of production.” For
instance, we want to increase the production of shoes.
The producer increases factors of production by 20%
and as a result the production of shoes increases by
35%. Thus, we can say that the production of shoes
obeys the Law of Increasing Returns. This law is also
known as the Law of Diminishing Costs. It means cost
per unit of the extra output falls as the industry
expands.
 Defintions

In the words of Marshall, "An increase of labour

and capital leads generally to improved
organisation which increases the efficiency of the
work of labour and capital. Therefore, an increase
of labour and capital generally gives a return
which increases more than in proportion."
According to Benham, "As the proportion of one
factor in a combination of factors is increased,
upto a point, the marginal productivity of the
factor will increase."
 Contd…

In the words of Mrs. Joan Robinson, "Increasing

Returns to a factor states that when an increasing
amount of a factor of production is employed it
generally brings about an improvement in
organisation. As a result of it, units of the factor
concerned become more efficient and to increase
production it will not be necessary to increase the
physical quantity of the factor in the same
proportion."
If the proportional increase in output (production) is
larger than that of the inputs, then we have
increasing returns to scale.
 ASSUMPTIONS

Some factors of production should be divisible

or variable.
Arrangement of fixed as well as variable factors
can be made more effective
At least one factor of production is divisible.
This law can explained in two ways
Law of increasing returns
Law of diminishing costs
Contd..
 Contd..
Table shows that one unit of labour and capital yields the
total production of 4. If one additional unit is employed, total
production increases to 10. The marginal production of the
second unit will be 6 (10-4) and average production will be
5. Likewise the employment to third unit of capital and
labour will raise the production to 5. Likewise the
employment of third unit of capital and labour will raise the
marginal production to 8 and average production to six.
The marginal and average production of the fourth unit will
be 10 and 7 respectively. The fifth unit will raise the
marginal production to 12 and average production to 8.
Thus, it shows that both marginal and average production
increase as a result of the increase in the factors of
production.
 Diagram
Increasing returns
 Law of diminishing cost

The law can also be explained in term of

diminishing costs. According to the law of
diminishing costs as the output increases, average
cost per unit goes on diminishing.
 Contd…

It is evident from table that with the application of

the first unit of labour and capital, average cost is
Rs. 10. With the application of the next unit,
average cost comes down to Rs. 8. With the
application of third, fourth and fifth units, it has
further fallen to Rs. 6.66, Rs. 5.71 and Rs. 5.00
respectively.
 Contd..

Diminishing cost
 Law of Constant Return

The Law of Constant Returns is said to operate

when the additional investment of labour and
capital yields the same return as before.
In other-words, it can be said that “whatever the
scale of production, the cost of the product per
unit remains the same.”
According to Stigler – “When all the productive
services are increased in a given proportion, the
product is increased in the same proportion.”
 Contd,,,,

Law of Constant Return remains active for some-time.

From where the activeness of Law of Increasing
Return ends, from there the Law of Constant Return
starts and after the end of the activeness of this Law of
Diminishing Return starts operation.
In other-words, it can be said that when the business
moves towards the optimum, the returns increase and
when it goes beyond the optimum the returns decrease.
But if after having reached the optimum point, the
industry is stabilized at the level of output, the returns
continue to be the same; and they are said to be
constant.
 Contd….

This law can be illustrated by the following

example:
From this table it is clear that by increase in the unit of
labour and capital, total production increases but the
marginal production remains constant i.e., 30 is the constant
figure; and this figure is Law of Constant Return.
In every industry, we find the influence of man and nature.
Nature controls the supply of raw-materials while man
directs the manufacturing side. If there is an industry where
the cost of raw-materials and the manufacturing costs are
half and half, we can say that both man and nature influence
equally. Such an industry would be subject to the Law of
Constant Returns.
For example – The woolen blanket weaving industry. Here
the cost of wool is supposed to cost as much as the other
manufacturing costs put in the manufacturing.
 Contd….

Further, if there is an integration of the extractive and

manufacturing industries like sugar-making and cane-growing,
steel making and iron-ore mining the Law of Constant Returns
may operate. Here, the two aspects of the industry are
combined, viz., the agricultural aspect which is subject to the
law of diminishing returns and the manufacturing aspect which
is subject to the Law of Increasing Returns.
It is possible for these two tendencies to counter­balance each
other with the result that the Law of Constant Returns may
operate. Thus, we find that in every industry there are two
tendencies and constantly at work viz., one of diminishing
returns and the other of increasing returns. Whenever this scale
of production is increased the cost of raw materials and other
factors may go up on account of increased demand.
 Contd…

This tends to raise the cost of production per unit or

to bring about the operation of the Law of
Diminishing Returns. But the larger the scale the
greater the economies in the use of machinery,
division of labour, buying and selling, research and
publicity etc.
In actual life, however, either the tendency of
diminishing returns is stronger or the increasing
returns tendency is stronger. Thus, the operation of
the Law of Constant Returns is rather rare and if at
all it operates, it lasts only for a short period of
time.