In economics, diminishing returns is the decrease in the marginal output of a production process
as the amount of a single factor of production is incrementally increased, while the amounts
of all other factors of production stay constant. The law of diminishing returns states that
in all productive processes, adding more of one factor of production, while holding all
others constant, will at some point yield lower incremental per-unit returns. The law
of diminishing returns does not imply that adding more of a factor will decrease the
total production, a condition known as negative returns, though in fact this is common.
For example, the use of fertilizer improves crop production on farms and in gardens; but
at some point, adding more and more fertilizer improves the yield less per unit of fertilizer,
and excessive quantities can even reduce the yield. A common sort of example is adding
more workers to a job, such as assembling a car on a factory floor. At some point, adding
more workers causes problems such as workers getting in each other's way or frequently
finding themselves waiting for access to a part. In all of these processes, producing
one more unit of output per unit of time will eventually cost increasingly more, due to
inputs being used less and less effectively. The law of diminishing returns is a fundamental
principle of economics. It plays a central role in production theory.
History The concept of diminishing returns can be
traced back to the concerns of early economists such as Johann Heinrich von Thünen, Jacques
Turgot, Adam Smith, James Steuart, Thomas Robert Malthus and David Ricardo. However,
classical economists such as Malthus and Ricardo attributed the successive diminishment of
output to the decreasing quality of the inputs. Neoclassical economists assume that each "unit"
of labor is identical. Diminishing returns are due to the disruption of the entire productive
process as additional units of labor are added to a fixed amount of capital. The law of diminishing
returns remains an important consideration in farming.
Diminishing marginal returns The defining feature of diminishing marginal
returns is that as total investment increases, the total return on investment as a proportion
of the total investment decreases. Suppose, for example, that 1 kilogram of seed applied
to a certain plot of land produces one ton of crop, that 2 kg of seed produces 1.5 tons,
and that 3 kg of seed produces 1.75 tons. In formulaic terms, the th kg of seeds produces
additional tons of crop. The return from investing the first kilogram is 1 t/kg. When 2 kg of
seed is invested, the return is 1.5/2 = 0.75 t/kg, and when 3 kg is invested, the return
is 1.75/3 = 0.58 t/kg. In formulaic terms, for this example, the
diminished marginal return is:
where = seed in kilograms, and = additional crop yield in tons, for the th kilogram of
seed. Substituting 3 for and expanding yields:
Another example is a factory that has a fixed stock of capital, or tools and machines, and
a variable supply of labor. As the firm increases the number of workers, the total output of
the firm grows but at an ever-decreasing rate. This is because after a certain point, the
factory becomes overcrowded and workers begin to form lines to use the machines. The long-run
solution to this problem is to increase the stock of capital, that is, to buy more machines
and to build more factories. Returns and costs
There is an inverse relationship between returns of inputs and the cost of production. Suppose
that a kilogram of seed costs one dollar, and this price does not change. Although there
are other costs, assume they do not vary with the amount of output and are therefore fixed
costs. One kilogram of seeds yields one ton of crop, so the first ton of the crop costs
one dollar to produce. That is, for the first ton of output, the marginal cost of the output
is $1 per ton. If there are no other changes, then if the second kilogram of seeds applied
to land produces only half the output of the first, the marginal cost would equal $1 per
half ton of output, or $2 per ton. Similarly, if the third kilogram of seeds yields only
a quarter ton, then the marginal cost equals $1 per quarter ton, or $4 per ton. Thus, diminishing
marginal returns imply increasing marginal costs and rising average costs.
Cost can also be measured in terms of opportunity cost. In this case the law also applies to
societies – the opportunity cost of producing a single unit of a good generally increases
as a society attempts to produce more of that good. This explains the bowed-out shape of
the production possibilities frontier. See also
Diminishing marginal utility, also not to be mistaken for 'diminishing returns'
Diseconomies of scale, does not assume fixed inputs, thus differing from 'diminishing returns'
Economies of scale Increasing returns
Learning curve and Experience curve effects Marginal value theorem
Opportunity cost Pareto principle
Submodular set function Tendency of the rate of profit to fall
Liebig's Law of the minimum References
Sources Case, Karl E.; Fair, Ray C.. Principles of
Economics. Prentice-Hall. ISBN 0-13-961905-4.