Law Of Diminishing Returns: Assumptions, Explanation, Causes, Importance and Limitations!
The main assumptions of the law are:
1. 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.
2. Short Period:
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.
3. Homogeneous Units:
All units of variable factors of production are assumed to be homogeneous.
4. Measurement of Product.
The output is measured in physical units like tones, kilograms etc.
Explanation of the Law:
The law of diminishing returns can be explained in two forms:
(1) Law of Diminishing Returns
(2) Law of Increasing Costs.
(A) Law of Diminishing Returns:
The law of diminishing returns can be illustrated with the help of a table 2 and a Figure 2.
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 fig. 2, units of labour and capital are given on OX-axis whereas marginal product is shown along OY axis.
Curve DR 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.
(B) 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 Fig. 3 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 for the Operation of Law of Diminishing Returns (General Application of the Law):
The causes for the operation of law of diminishing returns are discussed below:
1. Fixed Factors of Production:
The law of diminishing returns applies because certain factors of production are kept fixed. All factors of production, land, labour, capital or enterprise cannot be increased every time. As we know that production is the result of the effective combination of factors of production, every factor will have to be increased for obtaining production at increased rates.
If certain factor becomes fixed, the adjustment of factor of production will be disturbed and the production will not increase at increasing rates and thus law of diminishing returns will apply.
2. Scarce Factors:
In case of certain factors especially land which is itself limited cannot be increased the law of diminishing return will apply. It may also happen in case of other factors of production. For example, sometimes, labour, specially technical or capital or even enterprise cannot be increased in individual cases. As a result, the adjustment of factors of production will be disturbed and the output cannot be achieved at increasing rates.
3. Lack of Perfect Substitutes:
There is another reason due to which the law of diminishing returns does not apply i.e., lack of perfect substitutes of factors of production. It means that one factor of production cannot be substituted for another factor. Substitute for every factor of production is not always available. In the absence of such substitute, the law of diminishing returns will apply.
4. Optimum Production:
If the perfect adjustment of the factors of production has been made, certainly optimum production will be returned. After this optimum level of production, more and more variable factors will result in less efficient combination of fixed as well as variable factors of production. In other words, this, will reduce the marginal product and hence the law of diminishing returns will operate.
Fields Where the Law Applies Quickly:
Marshall has stated that the law of diminishing returns applies quickly to agriculture, mining, forests, fisheries and building industries. In case of land, it applies to both in its intensive and extensive form of cultivation.
“While the part which nature plays in production shows a tendency to diminishing returns, the part which may plays shows a tendency to increasing returns.” Dr. Marshall
In agriculture, nature plays the key role. It is due to this reason that the law of diminishing returns apply quickly to agriculture. In manufacturing industries, the application of the law is delayed. Modern economists do not agree with this view. They believe that the law applies because one factor is fixed. This fixed nature of the factor can be found in any field of production whether agriculture, industry or any other.
Now we study this one by one:
1. Application of the Law in Agriculture:
In agriculture, nature dominates, so the law of dominates, so the law of diminishing returns applies quickly. In agriculture, more and more doses of labour and capital can be employed with the fixed factor (i.e. land) to produce more. Land being fixed cannot be increased or reduced as per the choice of the agriculturist. Thus as more and more variable factors are employed with the fixed factors, the marginal product falls and hence the law of diminishing returns apply.
2. Application in Extractive Industries:
The law of diminishing returns applies quickly to the extractive industries like:
As more and more minerals are extracted from the mines, the levels of minerals go down. For deep extraction, there is need of light, oxygen, water, more labourers etc. All this would involve more expenses and hence the law of diminishing returns would operate quickly.
In a river or in a sea, as we go on catching more and more fish, the number of fish would fall around the bank or shore. Now for more catch of the fish, we have to go deep into river or sea. This would involve wastage of time in going into deep water and then coming back to the bank or shore. Also in deep sea, the number of catching may not be too big. Thus it is clear that the law of diminishing returns apply quickly to fisheries.
The law of diminishing returns applies quickly to multi-storey building. As the more and more storeys are built, the expenses on upper storeys increase as compared to lower storeys. Thus the law of diminishing returns apply to buildings too.
3. Application in Industries:
In industries, labour and capital play more role than land and these can be increased to any level. It is due to this reason that the law of increasing returns apply in industries. But this does not continue for very long. A stage reaches when the quality of these variable factors deteriorates or the prices of these variable factors increase. These two factors result in diminishing returns.
Thus it is clear that the law of diminishing returns apply to all types of production; sooner or later. That is why it is called, ‘Universal law,
“The Law of Diminishing Returns is a law of life and can be applicable anywhere and everywhere”. Wicksteed
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:
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:
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.