Law of increasing costs – definition and examples
The law of increasing costs states that when production increases so do costs. This happens when all the factors of production are at maximum output. Therefore, if your production rises from, for example, 100 to 200 units a day, costs will increase.
The factors of production are the elements we use to produce goods and services. Factors of production consist of four elements: land, labor, capital, and enterprise.
Bizfluent.com says the following regarding increasing costs:
“The law of increasing costs is an important consideration for business owners, who strive to keep their operations running at full capacity so as to achieve the highest level of profit possible.”
Increasing costs – example
Let’s suppose an imaginary bed company, XYZ Inc., wants to increase its production of beds. It wants to raise its monthly production by 1,000 units.
If the factors of production are already working to capacity, the additional beds will mean greater costs for the company.
The company will have to pay workers at overtime rates to meet the increase in production. Therefore, labor costs will increase considerably.
To produce more beds, the company will need to consume more energy. This is usually in the form of electricity.
Land and machinery costs are typically fixed. Therefore, land and machinery costs per unit will not rise.
Overall, however, if factors of production are at maximum capacity, there will be increased costs when production rises. In fact, costs per unit of the additional beds will be higher.
Increasing costs – profit margins
A company’s profit margins may decline because of higher costs resulting from producing those additional beds.
Profit margin is a measure of a company’s profitability. It is the amount by which its revenue from sales exceeds its costs.
The company may subsequently have to raise its prices to meet the increased costs of production.
It may have to raise prices if it wants to remain profitable.
Before agreeing to raise production, you should evaluate the situation carefully. Are you sure that your company should produce additional beds? In other words, is it in the company’s best interest?
Remember that factors of production are finite and the law of increasing costs is real.