by Sithambaranathan Prithiviraj

Created on: September 05, 2008

The law of increasing cost is a short-term economic cost concept of any enterprise. The main principle behind the law of increasing cost is after an enterprise achieves the maximum efficiency the total production cost per unit increases. That is the cost increases faster than the total production. This happens because after the maximum efficiency, the production efficiency will tend to be constant or decreasing and the cost tend to rise and there fore the unit cost tends to rise. This concept also is related to the concept of diminishing marginal productivity. That is if you add a factor of production to fixed factor of production like capital and land then after reaching the maximum total out put the marginal product produced by one unit of the variable factor declines. That is the total production tends to decrease.There fore the average cost per unit rises.

This is important for a firm in the short-term because after the maximum efficiency is reached it must not produce more because the cost per unit will rise and the price is determined by the level of demand and in a competitive market environment a firm is a price taker and it cannot raise the price because it will reduce demand. There fore if the firm produces after reaching the maximum efficiency its profit margin will be reduced because of increasing cost and there fore its profitability is reduced. However, if the business can combine with the same type of business and can create synergies and improve its operational efficiency after reaching the maximum efficiency. This can reduce production cost in the short-term. However, in the short-term, it is not feasible in practice. There fore, in the short-term the firm must not operate after it has reached the maximum efficiency. If it operates at a level more than the maximum level of efficiency its profitability will be reduced and it will lose its market value.This is, because profitability determines to a greater extent its market value.

The law of increasing cost is applicable to all firms because it is a basic law of economics. There fore managers of firms must be aware of this law to manage their operations and to determine the level of operations near the maximum efficiency of production atleast in the short-term. It is an important microeconomic concept, applicable to production or service provision particularly in a competitive market condition.

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