Law of increasing returns is an economic concept that explains how an increase in the production of goods can lead to a decrease in the average cost of production per unit. This law is based on the assumption that as the level of production increases, the efficiency of production also increases, resulting in lower costs of production. There are several reasons why this law works, and they are explained below.

Fuller utilization of fixed factors
One of the reasons why the law of increasing returns works is because of the fuller utilization of fixed factors. Fixed factors of production are resources that cannot be increased in the short run, such as land and capital. As the level of production increases, these fixed factors are used more efficiently, leading to a decrease in the average cost of production per unit. For example, if a factory produces 100 units of a product, the fixed costs will be spread over 100 units, resulting in a higher average cost per unit. However, if the factory produces 1000 units of the same product, the fixed costs will be spread over 1000 units, resulting in a lower average cost per unit.

Indivisibility of the factors
Another reason why the law of increasing returns works is because of the indivisibility of the factors. Indivisible factors of production are resources that cannot be used in smaller quantities, such as a machine or a factory. As the level of production increases, the use of these indivisible factors becomes more efficient, leading to a decrease in the average cost of production per unit. For example, if a factory has a machine that can produce 100 units of a product per day, the cost of the machine will be spread over 100 units, resulting in a higher average cost per unit. However, if the factory has a machine that can produce 1000 units of the same product per day, the cost of the machine will be spread over 1000 units, resulting in a lower average cost per unit.

Greater specialization of labour
The third reason why the law of increasing returns works is because of the greater specialization of labour. Specialization of labour occurs when workers focus on a specific task or activity, leading to an increase in productivity. As the level of production increases, the specialization of labour becomes more efficient, leading to a decrease in the average cost of production per unit. For example, if a factory has 10 workers who can produce 100 units of a product per day, the cost of labour will be spread over 100 units, resulting in a higher average cost per unit. However, if the factory has 100 workers who can produce 1000 units of the same product per day, the cost of labour will be spread over 1000 units, resulting in a lower average cost per unit.

In conclusion, the law of increasing returns works due to several reasons, including the fuller utilization of fixed factors, the indivisibility of the factors and greater specialization of labour. By understanding these reasons, firms can increase their production levels and decrease their average cost of production per unit, leading to higher profits and economic growth.