When every addition of the variable factor (i.e., labour and capital) causes more than proportionate increase in output, it is said to be the operation of law of increasing returns.
There are two important reasons for increasing returns: (i) indivisibility, and (ii) specialisation.
(a) Indivisibility:
Generally, the fixed factors which are combined with variable factors are indivisible. Such factors cannot be divided into smaller units, since division will result either in total uselessness or partial loss in efficiency.
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These indivisible factors produce smaller or larger quantities, almost with the same amount of expenditure. In the words of Stonier and Hague, “Most factors of production can be most efficiently employed at the output they were designed for and work less efficiently at smaller outputs because they cannot be divided into smaller units.
They are indivisible. A manager cannot be chopped in half and asked to produce half the current output. Plant cannot be used less fully without being used less economically”.
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Indivisibility of a factor means that due to technological requirement, a minimum amount of that must be employed, whatever is the level of output. In initial stages, the supply of the fixed factor is too large and it is indivisible. On the other hand, the variable factor units are too few. Thus, the fixed indivisible factor is not efficiently employed.
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When the units of the variable factor are increased and combined with this fixed factor, the latter is utilised better and more fully. This causes increasing returns, which continue till the best proportion between the fixed factor and variable factors is reached.
(b) Specialisation:
Another cause for increasing returns is the advantages offered by specialisation. Greater is the quantity of the variable factor, greater is the scope of specialisation. The most important advantages of specialisation of labour include better skill, productivity, efficiency, avoidance of waste of time in shifting from one task to another, employment of persons best suited to particular type of work, etc.
In assembly line production, cost of production is drastically reduced due to division of labour and specialisation. Each worker acquires manual dexterity and proficiency in the job assigned. It improves the quality of product produced and saves time.