Now the most important question is why the law operates. Why do we get increasing return in first stage, diminishing return in second stage and Negative Return in third stage?
Below we discuss some important causes.
(A) Causes of Increasing Returns (Diminishing Cost):
There are three important causes for the operation of increasing return in the first stage. These are:
ADVERTISEMENTS:
(i) Indivisibility of Fixed Factor:
In the beginning, the quantity of fixed factor is abundant relative to the quantity of variable factor. Therefore, when more and more units of variable factor are added to the constant quantity of fixed factor (indivisible factors like plant and machinery), then the fixed factor is more intensively and effectively utilized.
This causes the production to increase at a rapid rate. Take for example, one pump set has capacity to irrigate 5 acres of land in a year and the cost of pump set is Rs. 15,000. If the former irrigates one acre of land with that pump set, then unit cost will be (15,000 -r 1 = Rs. 15,000) (entire cost is borne by him).
Image Source: image.slidesharecdn.com
ADVERTISEMENTS:
On the other hand, if he irrigates 5 acres of land with that pump set, the unit cost per acre will be (15,000 -r 5 = Rs. 3,000) Rs. 3,000 only. Thus, a pump set being an indivisible factor, its cost can be decline if it is utilized up to its optimum capacity. So fuller utilization of indivisible factor leads to increasing return or decreasing costs.
(ii) Division of Labour and Specialization:
The second reason why we get increasing returns at the initial stage is that as more units of the variable factors are employed the efficiency of the variable factor itself increases.
This is because when there is a sufficient quantity of the variable factor, it becomes possible to introduce specialization or division of labour which results in higher productivity. Higher productivity leads to decrease in cost per unit.
ADVERTISEMENTS:
(iii) Economies of Large-Scale Production:
Third reason for the increasing return or diminishing cost in the first stage is the economies of large scale production. Here economies of production relates to external economies.
It includes economies of buying and selling, financial, technical managerial economies etc. When a farm expanse its production it may some benefited due to external economies which ultimately help to reduce cost per unit of output.
(B) Causes of Diminishing Returns (Increasing Cost):
The law of Diminishing return can be called as the law of increasing cost. The causes of diminishing return are follows.
(i) Over-utilization of the fixed factor (Inadequacy of fixed factor):
Once the point is reached at which the amount of variable factor is sufficient to ensure the efficient utilization of fixed factor, the further increase in variable factor will cause marginal and average product to decline because the fixed factor then becomes inadequate in relation to the quantity of variable factor.
In other words the contributions to the production made by the variable factor after a point become less and less because the additional units of the variable factors have less and less of fixed factors to work with.
(ii) Imperfect Substitutability of the Factors:
Joan Robinson goes deeper into the causes of diminishing returns. She holds that the diminishing returns occur because the factors of production are imperfect substitute for one another.
According to her, if factors are perfectly substitute of one another, neither increasing return nor diminishing return occurs. Therefore, due to imperfect substitutability of factors diminishing return in production occurs.
(C) Causes of Negative Returns:
The phenomenon of negative returns in Stage-Ill is due to the fact that the number of variable factors becomes too excessive relative to the fixed factor so that they get in each other’s way with the result that the total output falls instead of rising.
In other words, due to excessive variable factors, there would be mismanagement, lack of supervision, overcrowding, lack of coordination, which ultimately results in decrease in production. The proverb “Too many cooks spoil the broth” aptly applies to this situation. In this stage the marginal product of variable factor is negative.