Confusion on the ceteris paribuses

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Alan Mitchell’s “Spiralling increase in returns” (MW June 21) confuses the law of diminishing returns with the theory of marginal utility.

Diminishing returns result from the combination of a fixed resource (land for example) with a variable input (such as labour or capital). The marginal increase in production resulting from a further input reduces with each additional input.

At some point the additional input results in an actual reduction in output. This rule also acknowledges increasing returns since there is (at least in theory) an optimal combination of the three production factors of land, capital and labour. All this, as economists would say, assumes ceteris paribus.

The fact that I as a consumer receive a reduced benefit from additional purchases of a given good refers to the theory of marginal utility. This is unrelated to production factors, simply reflecting the fact that if I buy a second video recorder, its value is less to me than the first.

What economists observe is that both theories are not static – technology, income levels and public attitudes cause them to change over time. The development of new fertilisers allows farmers to increase the optimum level of production from land, thereby giving the impression that the law of diminishing returns does not apply.

It does but the higher optimum point means that returns increase for a longer period. So long as business can combine increased inputs with technological advance or organisational changes, returns will increase.

While Alan is right about the need for businesses to change their thinking about co-operative marketing, this is unrelated to the law of diminishing returns since it acts to extend the size of the fixed variable, thus making the law of diminishing return invalid. Non ceteris paribus.

Simon Cooke

The Cooke Consultancy


West Yorkshire

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