This paper examines the empirical validity of law of diminishing returns
to capital across 127 Indian industries (factory sector) for the year
1999-2000 by fitting a quadratic production function. The empirical
evidence on the basis of sign, size and statistical significance of the
regression coefficients of the capital and square of capital shows that
the marginal product of capital is eventually diminishing, confirming
that the law of diminishing returns to capital, all else being equal, is
operating across the Indian industries.
The empirical information on the nature of returns to variable, input, capital in the Indian
industrial sector is indispensable as it guides the producers in making one of the operational
management decisions either to increase or reduce the extent of capital in the process of
production, all else being equal. So far as the empirical information on the nature of returns
to variable, the behavior of production to the changes in one variable, in the Indian industrial
sector, is concerned, though there are a few time series studies at hand, the empirical
studies on the nature of returns to variable input, capital, across the Indian industries are
almost nonexistent. Therefore, the present exercise is a trifling endeavor in this direction
using most recent cross-section data available for the Indian industrial sector.
Law of Diminishing Returns states that when technology of production and some of the
inputs are held constant [fixed inputs] and quantity of variable input [that varies with the
level of production], capital, increases, the marginal product of variable input, capital, will
eventually diminish. There are three stages of Law of diminishing returns. In the first stage
Total Production (TP), increases at an increasing rate. This stage comes to an end when
Average Product (AP) is maximum and also AP = MP (Marginal Product). It is the stage of
increasing returns. In the second stage, AP and MP fall, but TP increases. This stage is called
the stage of diminishing returns. In this stage, a firm decides its level of production. Third
stage starts when MP = 0 and TP is maximum. In this stage, TP starts falling and slope of TP
curve becomes negative. MP becomes negative. This stage is called the stage of negative
returns. This law is based on the assumptions that [1] there is no change in the techniques of
production [2] one input capital is variable while other inputs are fixed and [3] there is a
short period of operation. The law operates in the field of agricultural and industrial
production. |
