The Law of Increasing costs states production increases with higher costs. When all factors of production are at their maximum output, this is called a “maximum output.” If your increase in production goes from 50 to 100 units per day, the costs will rise.
Example of Increasing cost
This is best shown by looking at an example of an economy that produces only apples and bikes. All the economic resources are used to make apples. There won’t be enough factor of production available for bicycles. The result is a production of X amount of apples but zero bikes.
It is also possible to produce zero apples if all factors of production are utilized for bikes production. There are two possible outcomes: some apples are produced, and some bikes are not. These possibilities are based on three assumptions. Full employment is a reality in the economy.
This means that everyone who needs to work is employed. The best technology is being used, and production efficiency is maximized. The question is, how much does it cost to produce more bikes or apples? The cost of each unit will go up if the economy has reached its maximum input levels.
To produce the unit, the economy will need to cover more variable costs such as overtime.
This law also applies to Switch Production in an economy that is maxed out. The economy is still Producing. The law applies even if there is more.
Only the difference is that resources are taken from one area and used in another place, rather than being produced more.
Importance of Law increasing cost
It is vital to understand the law of rising costs. This will allow you to run your business efficiently and make the most profit. Understanding the law of increasing costs can help you avoid losing opportunities costs while producing products and make informed production decisions for your company.
The law of increasing opportunity costs can also help you allocate production resources. This is valuable information for resource managers.
When should the law of increasing cost be used?
Before your business increases mass production of a product, it is a good idea to think about the law of increasing costs. It can be helpful to view your current situation from the perspective of a production possibility frontier to understand the law that increases cost.
A production possibility frontier, production possibility border, or production possibility curve is a symmetrical curve that demonstrates the variation in rates of production of the underlying variables. It may be called either curve because it traces a successful transition of the variable y from one state to another over a range of possible values of x.
In economics, a production possibilities frontier illustrates the deviation of prices from the average demand in the economy. The distribution of potential profits over time or distribution of investment income between different forms of investment also occurs along a production possibility curve.
Finally, the production possibilities frontier illustrates the point at which a producer will consider any investment opportunity to be an investment opportunity if the opportunity costs associated with such investment are less than the returns on such investment.
A production possibility frontier helps visualize the potential output combinations of goods your business could produce if it tried to make two products that used the same set of resources. This will help you to make the most profitable production decisions for your company.
Does the law of increasing cost apply to every situation?
Production situations are not always subject to the law of increasing costs. Suppliers can sometimes delay or avoid the consequences of the law of rising costs by changing the production methods they use. To offset increased production costs, suppliers could use a cheaper material.
The Law in Action
The law of rising costs is a constant above a certain level. You open a bakery, and the daily bread demand is less than the bread you can bake. You can bake more bread if the demand for it increases.
It gets more complicated once you reach your full potential. You might hire a baker to make 20 more loaves per day, but there is not enough demand for 7 or 8 loaves, and your labor costs will rise.
Economists discovered that the law of rising costs could be translated into a graph. Each business is different, but it should be possible to calculate the point at the law of diminishing returns.
Do Returns Always Diminish?
In some cases, the law of increasing cost doesn’t apply. The law assumes that everything else will remain the same, except for an increase in output. If you are unable to increase output, change your method of production, you may be able to work around diminishing returns.
Consider, for example, that you have a finite supply of raw material. The price of raw materials goes up as a result. The law of rising costs might not apply if you can find a substitute material for the original.
If your production methods can be improved, you may also be able to increase your profits and push down costs. The revolutionary technological changes that have occurred since the law of diminishing return were first formulated by old-time economists.
Law of Diminishing Marginal Returns
The law of diminishing marginal returns essentially states that adding a factor of manufacturing results in lower increases in output than the original increase of the input. The diminishing marginal return curve explains why increasing inputs reduces output and why decreasing inputs should be avoided whenever possible.
Once some optimum level of input capacity is achieved, the subsequent addition of any higher amounts of a specific factor of manufacturing will inevitably yield smaller increases in output than in the absence of that extra variable.
In essence, the law of diminishing marginal returns limits the usefulness of adding additional input to a production process. This is why the business world tends to focus on inputs other than on the quality of the finished product when determining the output value of their products.