Law of Increasing Returns: Meaning, Factors Responsible and Limitations

Let us make an in-depth study of the Law of Increasing Returns:-

1. Meaning of the Law of Increasing Returns 2. Where the Law of Increasing Returns Operate and Why? 3. Factors Responsible 4. Limitations.

Meaning and Definition of Law of Increasing Returns:

The Law of Increasing Returns may be defined as such — “As the proportion of one factor in a combination of factors is increased up to a point, the marginal product of the factor will increase. The phrase ‘up to a point’ may be carefully noted. The increasing return will be only up to a point. Later on, the return may diminish.”

According to Prof. Marshall – “An increase in labour and capital leads generally to improve organisation which increases the efficiency of the work of labour and capital.”

The Law of Increasing Return is the opposite of the law of decreasing return, where the law of diminishing return operates, every additional investment of capital and labour yields less than proportionate returns. But in the case of the Law of Increasing Returns, the return is more than proportionate.

The law can be expressed in terms of costs also. Increasing returns mean lower costs per unit, just as diminishing returns mean higher cost. Thus the Law of Increasing Returns signifies that cost per unit of the marginal or additional output falls with the expansion of an industry. As more and more units of commodity are produced the cost per unit goes on falling steadily.

The Law of Increasing Returns operates only up to the optimum point, i.e., the point of maximum return. As a business expands and moves towards the optimum the return per unit goes on increasing i.e., the cost of production is falling.

If the business is expanded beyond the optimum point, the profits will begin to decline and the law of diminishing return begins to operate.

For example:

Suppose a fountain pen manufacturer invests successive doses of Rs. 1,000 each in the production of pens and the results are as given in the schedule below:

The table makes it clear that as the manufacturer goes on enlarging his business by investing successive amounts of Rs. 1,000 each. The total output goes on increasing (column 2), the cost of production per pen goes on falling (column 3) and the marginal or additional output of each extra dose of Rs. 1,000 goes on increasing, (column 4).

We can show the above result with the help of a diagram also. The diagram shows the decreasing cost as shown in column (3). Along OX are measured the total quantity of pens manufactured and along OX, the cost of production per pen. IR is the cost curve. It is clear that as the scale of production increases the cost of per unit falls.

Where the Law of Increasing Returns Operates and Why?

The Law of Increasing Returns generally applies to manufacturing industries. Here man is not disturbed by nature. He goes ahead and benefits from all sorts of economies both internal and external. As he increases the scale, production becomes more and more economical. The cost of production falls which means an increasing return.

Why Does the Law Operate in Big Manufacturing Industries?

There are several reasons on account of which the Law of Increasing Returns operates in manufacturing industries:

(1) There is a large scope for the introduction of machinery. Further, it can be considered as more important that it can be kept continuously at work. The result is that capital costs per unit of output are less.

(2) There is maximum scope for the use of specialised labour. The result is a large output, which means the lowering of costs. This means increasing returns.

(3) The manufacturing industries are generally on a large scale, are able to realise economies of scale both internal and external. These economies relate to buying and selling economy in administration, publicity and salesmanship, benefit for research and experiments, financial, technical and managerial economies etc.

(4) Unlike agriculture, interruptions in work from natural disturbances like changes in weather and seasons are on a minor scale. Therefore, there are no costly breakdowns. Production is smooth and economical which means increasing returns.

(5) The operations are carried on within a small area so that supervision is easy and effective. There is little waste of materials and spoiling of machinery. Expert guidance and advice are always at hand. Therefore, production can be carried on economically.

It is on account of all these reasons that the Law of Increasing Returns operates in industry. But it must be remembered that the business cannot go on expanding it’s indefinitely. There comes a time when economies change into diseconomies as the business becomes unwieldy.

Factors Responsible for the Operation of the Law of Increas­ing Returns in the Field of Production:

Following are the important reasons for the operation of the Law of Increasing Returns in the field of production:

1. Improved Organisation:

Prof. Marshall has said that the important reason for the operation of Law of Increasing Returns is that “an increase of labour and. capital leads generally to improve organisation which increases the efficiency of the work of labour and capital.” Hence, it can be said that an increase in the efficiency of labour and capital in production increases the proportion of production.

2. Indivisibility of Factors:

Next, reason is the indivisibility of factors or means introduced in production. In the field of production there are certain means which cannot be used in small division or in small parts which can increase production.

3. External and Internal Economies:

In some production due to increase in the means of production. Some economies in external and internal means are studied and is enforced which leads to reduction in production cost.

4. Use of Division of Labour and Specialisation:

When large scale production is adopted. Use of division of labour and specialisation in work becomes possible. In this way the cost can be reduced and production may be increased.

5. Scientific Inventions and the Use of New Techniques:

By the new scientific inventions and the use of new technical appliances the production can be increased and the cost of production can be reduced.

Regarding Law of Increasing Returns Mrs. Joan Robinson has said that:

“In every case, the Law of Increasing Returns arise from improvement in production technique. As output increases efficiency of the factors can be increased by the full utilisation of indivisible units of the factors or by the adoption of more specialised methods of production.”

Limitations of the Law of Increasing Returns:

Important limitations of the Law of Increasing Returns are as follows:

1. If the size of the production unit is large and efficient management is not possible, then in this area the Law of Increasing Return will not operate.

2. If the machines and other instruments and tools are old even by increase in labour and capital the Law of Diminishing Return will apply.

3. If the industry needs rationalisation and division of labour, and if this is not introduced or followed, then in place of increasing return Law of Diminishing Return will operate.

4. If the industry is based on nature, then Law of Increasing Return will not operate.

5. If the use of advertisement is not adopted the use of Law of Increasing Return is not possible.