Introduction
In the theory of production, a firm combines various factors of production such as land, labour, capital and entrepreneurship to produce output. When we examine the relationship between one factor (taken as variable) and output, keeping other factors constant, we study what are known as the laws of return to a factor or simply the laws of return to factors.
In classical economics, and in your prescribed text “Microeconomics” by T.R. Jain & V.K. Ohri for B.Com Semester I, three traditional laws are recognised:
- Law of Increasing Returns
- Law of Constant Returns
- Law of Diminishing Returns (or Decreasing Returns)
These three laws together describe how the marginal and total productivity of a single variable factor changes when it is applied in varying proportions to a fixed factor. In modern analysis, they are unified and generalised in the Law of Variable Proportions, but for examination purposes Panjab University still expects a separate and systematic treatment of the “various laws of return to factors”.
Meaning of Laws of Return to Factors
The term return to a factor refers to the additional output obtained by using extra units of that factor while keeping all other factors constant. As more and more units of the variable factor (say, labour) are employed with a fixed factor (say, land or machinery), the extra or marginal return from each additional unit of the factor may increase, remain constant or decrease. This gives rise to three laws of return.
The various laws of return to factors explain how output responds when the quantity of one factor is changed, other factors being held constant. They show that the extra output per additional unit of that factor may increase, remain constant or decrease, giving rise respectively to the laws of increasing, constant and diminishing returns.
Common Assumptions
All three laws of return to factors are based on certain common assumptions:
- Short-run framework: At least one factor (e.g., land, plant size, machinery) remains fixed; only one factor is varied.
- Homogeneous factor units: Each additional unit of the variable factor is identical in quality and efficiency.
- Constant technology: The level of technology, methods of production and managerial skill remain unchanged.
- Rational behaviour: The producer is rational and aims at maximising profit or at least output for a given cost.
- Divisibility: The variable factor can be employed in small, divisible units.
- Perfect competition: The firm operates under competitive market conditions; no monopolistic disturbances are assumed in the basic analysis.
Illustrative Production Schedule
Consider land as a fixed factor and labour as a variable factor. Suppose the following simplified schedule is obtained when more units of labour are employed on a given piece of land:
| Units of Labour (Variable Factor) |
Total Product (TP) |
Marginal Product (MP) |
Nature of Returns to Factor |
|---|---|---|---|
| 1 | 8 | 8 | – |
| 2 | 18 | 10 | Increasing Returns |
| 3 | 28 | 10 | Constant Returns |
| 4 | 36 | 8 | Diminishing Returns |
| 5 | 42 | 6 | Diminishing Returns |
From this schedule we can clearly see that marginal product (MP) first increases, then remains constant, and afterwards decreases. These three phases form the basis of:
- Law of Increasing Returns (MP rising)
- Law of Constant Returns (MP constant)
- Law of Diminishing Returns (MP falling)
Diagrammatic Presentation of the Three Laws
The various laws of return to factors can be shown with the help of total product curves, each corresponding to a different situation.
1. Law of Increasing Returns
Statement
The Law of Increasing Returns states that as more units of a variable factor are applied to a fixed factor, total product increases at an increasing rate and the marginal product of the variable factor rises, at least over a certain initial range.
When additional units of a variable factor are employed with a fixed factor, the marginal product of the variable factor may increase so that total product rises at an increasing rate. This phase is described as the Law of Increasing Returns.
Explanation
In the initial stages of production, the fixed factor is usually underutilised. When more units of the variable factor are added:
- The fixed factor is used more intensively and efficiently.
- Specialisation and division of labour become possible.
- Work can be organised in a more efficient manner.
As a result, marginal product rises and each additional unit of the variable factor contributes more to output than the previous unit. This leads to increasing returns.
Causes of Increasing Returns
- Better utilisation of fixed factor (removal of underutilisation).
- Division of labour and specialisation among workers.
- Improved coordination between fixed and variable factors.
- Indivisibility of fixed factors which become more productive when combined with additional variable factor.
2. Law of Constant Returns
Statement
The Law of Constant Returns states that as additional units of a variable factor are applied to a fixed factor, total product increases at a constant rate and marginal product remains constant.
If equal increments of a variable factor, applied to a fixed factor, add equal amounts to total product, so that marginal product remains constant, we say that the Law of Constant Returns is operating.
Explanation
After the stage of increasing returns, a point is reached where the fixed factor is more or less fully utilised. Any further addition of the variable factor neither improves nor worsens the efficiency of the fixed factor. In this intermediate zone:
- Each extra unit of the variable factor adds the same amount to total product.
- Total product increases in a linear fashion.
- Marginal product is constant; average product remains unchanged.
Constant returns form a transitional phase between increasing and diminishing returns. In practice, it may be short-lived, but in theoretical analysis it helps to distinguish and complete the sequence of laws of return to factors.
3. Law of Diminishing Returns
Statement
The Law of Diminishing Returns (or Law of Diminishing Marginal Returns) is one of the oldest and most important laws in economics. It states that as more and more units of a variable factor are applied to a given fixed factor, keeping technology constant, the marginal product of the variable factor ultimately diminishes, and may even become negative.
If equal increments of a variable factor are applied to a given quantity of fixed factor, after a certain point the marginal product of the variable factor diminishes and total product increases at a diminishing rate, and may finally decrease. This is known as the Law of Diminishing Returns.
Explanation
Once the fixed factor has been more or less fully utilised, any further addition of the variable factor causes pressure on the fixed factor. For example, too many workers working on the same piece of land or same machine will begin to get in each other’s way.
- Each additional unit of variable factor has less fixed factor to work with.
- Overcrowding and congestion lead to falling efficiency.
- Therefore, marginal product falls and total product increases at a diminishing rate, and may ultimately fall.
Causes of Diminishing Returns
- Fixity of some factors: Land or plant size cannot be expanded in the short run.
- Overcrowding of variable factor: Too many workers on the same land or machine.
- Imperfect substitutability: Variable factor cannot completely substitute the fixed factor.
- Managerial difficulties: With too many workers and limited supervision, control becomes difficult.
Classical Example (Agriculture): When increasing doses of labour and fertilisers are applied to a fixed piece of land, initially output may rise rapidly. But beyond a point, further additions cause smaller and smaller increases in output, and ultimately output may even fall if the land is overworked.
Summary: Comparison of the Three Laws
| Aspect | Law of Increasing Returns | Law of Constant Returns | Law of Diminishing Returns |
|---|---|---|---|
| Behaviour of TP | Rises at an increasing rate. | Rises at a constant rate. | Rises at a diminishing rate, may eventually fall. |
| Behaviour of MP | MP increases. | MP remains constant. | MP decreases, may become zero or negative. |
| Stage of Production | Initial stage; underutilisation of fixed factor. | Intermediate balancing stage. | Later stage; overutilisation and congestion. |
| Economic Interpretation | Improved utilisation and specialisation. | Fully adjusted factor combination. | Overcrowding of variable factor; fixed factor becomes limiting factor. |
Relation with the Law of Variable Proportions
The three laws of return to a factor are historically older formulations. Modern microeconomics, as presented by T.R. Jain & V.K. Ohri, unifies them into the more general Law of Variable Proportions, which describes three stages of production: increasing returns, diminishing returns and negative returns.
Thus, the various laws of return to factors can be seen as different phases of the same underlying relationship between a variable factor and output in the short run. They are not contradictory laws but complementary aspects of a single comprehensive law.
Importance of the Laws of Return to Factors
The various laws of return to factors have great theoretical and practical importance:
By understanding how output responds to additional units of a variable factor, the producer can decide how much labour or other input to employ. The rational range is where marginal product is positive but diminishing (i.e., before MP becomes negative).
The shape of short-run cost curves (especially marginal cost and average variable cost) is closely related to the law of diminishing returns. When MP rises, marginal cost falls; when MP falls, marginal cost rises.
In agriculture, the law of diminishing returns explains why simply adding more labour and fertiliser to a fixed piece of land cannot indefinitely increase output. It highlights the need for new techniques and expansion of fixed factors. In industry, it guides the decision about when to expand plant size.
The study of factor–output relationships begins with the laws of return to a factor and later extends to returns to scale and cost–output relations. Thus, these laws are the foundation of production analysis in microeconomics.
Conclusion
To sum up, the various laws of return to factors explain how the productivity of a single variable factor changes when it is applied in varying quantities to a fixed factor, in the short run. The law of increasing returns operates when the fixed factor is underutilised and specialisation is expanding; the law of constant returns prevails when factor combinations are optimally balanced; and the law of diminishing returns applies once the fixed factor becomes a limiting factor and additional units of the variable factor add less and less to total output. Taken together, these laws form an essential part of the production theory in your Microeconomics syllabus and provide a logical stepping stone towards the more general law of variable proportions and the analysis of cost behaviour.