The Laws of Diminishing and Increasing Returns

Answer

1. • The Laws of Diminishing and Increasing Returns

     Economic gains form the focus of most business engagements. Ideally, they help realize the maximum possible returns while minimizing the cost of inputs or expenses. Usually, economists employ various laws to predict outputs and make decisions on whether to have more input channeled into a process or not. Notably, the laws of diminishing returns and increasing returns are some of the commonly used guiding principles in business, especially regarding the input of resources into a business. The primary advantage of understanding these laws is that they help predict the approximate returns in both the short and long run for a business based on the nature and level of inputs. 

     The Law Of Diminishing Returns

     The law of diminishing returns states that when additional or increasing units of a particular variable input are utilized in the production process while other variable inputs remain constant, the total output realized may increase at an increasing rate then at a constant rate and finally will start declining. According to Alfred Marshall, who uses an example of a farming enterprise, an increase in capital inputs on land cultivation causes a less proportionate increase in the produce realized unless other factors are also varied.

     The definition of the law of diminishing returns is confusing as it focuses on a single variable input and not all inputs. For instance, in the land cultivation enterprise, the increase is only on labor and not capital, the size of land, or improvements in farming techniques (Blum & Holling, 2017). Similarly, the focus on output is only on marginal returns. In this regard, the nominal output remains constant. However, increments are witnessed in marginal outputs, which increase at the start, remain constant, and then decrease to fall back to the initial output level before the initial increment in one factor of production. 

     The development and application of the diminishing law or returns are based on various assumptions. Primarily Lewis and Rao (2015) explain that the law assumes that capital remains constant while labor is the only variable factor of production. Moreover, labor is assumed homogeneous, while the state of technology relating to the economic process under consideration is given or explained. Similarly, the law of diminishing returns assumes that the production process is provided.

     Example

     The law of diminishing returns can be best understood using an example of a fishing business. In this regard, the company makes a profit by selling the caught fish. Therefore, the more the fish, the higher the returns. In the business, the company has all the necessary machinery ranging from boats to fishing lines as the capital for the business while labor is the fishermen who use the capital or available equipment. 

     The production function for a labor output relation is often assumed as

     Qc = -L3 + 30L3 + 20L

     Where Qc = Total Output

     L = labor.

     To increase output, the company can hire more labor or fishers. As such, the corresponding values for the total outcome can be realized by substituting L with the number of fishermen or staff available to the company.

     On the other hand, the marginal product of labor is obtained by use of a formula.

     MPl = Changes in outputChanges in Labour

     Lastly, the average product of labor is obtained by use of a formula.

     APL = QcNumber of workers

     The law of diminishing returns occurs in three stages. The first stage is characterized by an increase in total output as more units of labor or one factor of production increases. Stage two refers to the interval in which there is an increase in total output while the marginal products begin to decline with increasing labor inputs. A declining total product characterizes the last stage as more units of labor are added. 

      

     The Law of Increasing Returns

     The law of increasing returns is also referred to as the law of diminishing costs, and it holds that when more unit of a particular variable factor of production such as labor is utilized in the production process while other variables remain fixed, the total production increases at a higher rate. The increase is realized due to the tendency of the marginal cost to increase per each unit of a production factor added. According to Hervas-Oliver et al. (2018), the increase in total output continues unless deficiency occurs in any other factor that is essential to production, as this usually has adverse effects on the level of the marginal product realized. If a deficiency occurs in another essential factor of production, there will be a decline in the marginal product, which depicts the law of diminishing returns. 

     Practical Application 

     The law of increasing returns functions mainly in situations where production on a large scale leads to the realization of economies of scale, thereby resulting in high output. Another area where the law of diminishing returns operates is where plants may be operating bellow their capacity in that an increase in any factor of production results in increased output. The main assumptions under the law of increasing returns include there being divisible in some factors, having a scope in the enhancement of production techniques, and one factor of production has to be indivisible.