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. In this scenario, increasing output means higher production costs due to higher production. This illustrates the law of increasing costs.
A central assumption among economists is that business owners seek to achieve maximum production levels, given their firms' available factors, or inputs. Factors of production include land, machinery and the company's work force. These inputs have costs--land and machinery must be maintained, and employees must be paid.
When factors of production are used at their full capacity (to operate at a lower capacity would be inefficient), the law of increasing costs holds that an increase in output brings with it a higher cost for each additional unit of output.
Suppose a company that manufactures computers decides to increase its monthly output by 2,000 laptop units. Assuming that the company is operating efficiently, the additional laptops will be more costly per unit to produce. These increasing costs would likely consist largely of overtime wages paid to employees working extra hours to meet the higher production levels. The costs of land and machinery are generally fixed and not likely to increase as a result from stepped-up production levels. Labor, however, is a variable cost; additional output requires additional input in the form of more employees or overtime wages.
Because of higher costs from stepped-up production, a company's profit margins may be reduced. This could result in higher prices for the company's products to meet the higher costs of production and still maintain profitability.
Before deciding to increase production, company managers should carefully evaluate the situation and decide whether the additional units of output are in the company's best interest, given the law of increasing costs and that factors of production are finite.
The law of increasing costs is similar to another economic concept known as the law of diminishing returns. The latter holds that the benefit of additional levels of input declines as the units of input increase. For example, when workers have ample equipment with which to produce goods, additional equipment may result in only small increases in worker productivity.