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In economics, diminishing returns (also called diminishing marginalreturns) refers to how the marginal production of a factor of production starts to progressively decrease as thefactor is increased, in contrast to theincrease that would otherwise benormally expected. According to thisrelationship, in a production systemwith fixed and variable inputs (say

factory size and labor), eachadditional unit of the variable input(i.e., man-hours) yields smaller andsmaller increases in outputs, alsoreducing each worker's meanproductivity. Conversely, producingone more unit of output will costincreasingly more (owing to themajor amount of variable inputsbeing used, to little effect).

This concept is also known as thelaw of diminishing marginalreturns or the law of increasingrelative cost.

Contents: 1. Statement of the law 2. History 3. Examples 4. Returns and costs 5. Returns to scale 6. See also

7. References 8. Sources

1. Statement of the law

The law of diminishing returns hasbeen described as one of the most

famous laws in all of economics. [1] Infact, the law is central to production

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theory, one of the two majordivisions of neoclassicalmicroeconomic theory. The lawstates "that we will get less and lessextra output when we add additionaldoses of an input while holding otherinputs fixed. In other words, the

marginal product of each unit of input will decline as the amount of that input increases holding all other

inputs constant." [2] Explainingexactly why this law holds true hassometimes proven problematic.

Diminishing returns and diminishingmarginal returns are not the samething. Diminishing marginal returnsmeans that the MPL curve is falling.

The output may be either negative orpositive. Diminishing returns meansthat the extra labor causes output tofall which means that the MPL isnegative. In other words the changein output per unit increase in labor is

negative and total output is falling. [3]

2. History

The concept of diminishing returns

can be traced back to the concerns of early economists such as JohannHeinrich von Thünen, Turgot,Thomas Malthus and David Ricardo.However, classical economists suchas Malthus and Ricardo attributed thesuccessive diminishment of output tothe decreasing quality of the inputs.Neoclassical economists assume thateach "unit" of labor is identical =perfectly homogeneous. Diminishingreturns are due to the disruption of

the entire productive process asadditional units of labor are added toa fixed amount of capital.

Karl Marx developed a version of thelaw of diminishing returns in histheory of the tendency of the rate of profit to fall, described in Volume IIIof Capital.





3. Examples

Suppose that one kilogram of seedapplied to a plot of land of a fixedsize produces one ton of crop. Youmight expect that an additionalkilogram of seed would produce anadditional ton of output. However, if there are diminishing marginalreturns, that additional kilogram willproduce less than one additional tonof crop (ceteris paribus). Forexample, the second kilogram of seedmay only produce a half ton of extraoutput. Diminishing marginal returnsalso implies that a third kilogram of seed will produce an additional crop

that is even less than a half ton of additional output, say, one quarter of a ton.

In economics, the term "marginal" isused to mean on the edge of productivity in a production system.The difference in the investment of seed in these three scenarios is onekilogram — "marginal investment inseed is one kilogram." And thedifference in output, the crops, is one

ton for the first kilogram of seeds, ahalf ton for the second kilogram, andone quarter of a ton for the thirdkilogram. Thus, the marginalphysical product (MPP) of the seedwill fall as the total amount of seedplanted rises. In this example, themarginal product (or return) equalsthe extra amount of crop produceddivided by the extra amount of seedsplanted.

A consequence of diminishingmarginal returns is that as totalinvestment increases, the total returnon investment as a proportion of thetotal investment (the average productor return) decreases. The return frominvesting the first kilogram is 1 t/kg.The total return when 2 kg of seedare invested is 1.5/2 = 0.75 t/kg,





while the total return when 3 kg areinvested is 1.75/3 = 0.58 t/kg.

This particular example of Diminishing Marginal Returns in

formulaic terms: Where =

Diminished Marginal Return, =

seed in kilograms, and = cropyield in tons gives us:

Substituting 3 for and expandingyields:

Another example is a factory that hasa fixed stock of capital, or tools andmachines, and a variable supply of labor. As the firm increases thenumber of workers, the total outputof the firm grows but at an ever-decreasing rate. This is because aftera certain point, the factory becomes





overcrowded and workers begin toform lines to use the machines. Thelong-run solution to this problem is toincrease the stock of capital, that is,to buy more machines and to buildmore factories.

4. Returns and costs

There is an inverse relationshipbetween returns of inputs and the costof production. Suppose that akilogram of seed costs one dollar, andthis price does not change; althoughthere are other costs, assume they donot vary with the amount of outputand are therefore fixed costs. Onekilogram of seeds yields one ton of

crop, so the first ton of the crop costsone extra dollar to produce. That is,for the first ton of output, themarginal cost (MC) of the output is$1 per ton. If there are no otherchanges, then if the second kilogramof seeds applied to land producesonly half the output of the first, theMC equals $1 per half ton of output,or $2 per ton. Similarly, if the thirdkilogram produces only ¼ ton, thenthe MC equals $1 per quarter ton, or$4 per ton. Thus, diminishingmarginal returns imply increasingmarginal costs. This also impliesrising average costs. In this numericalexample, average cost rises from $1for 1 ton to $2 for 1.5 tons to $3 for1.75 tons, or approximately from 1 to1.3 to 1.7 dollars per ton.

In this example, the marginal costequals the extra amount of money

spent on seed divided by the extraamount of crop produced, whileaverage cost is the total amount of money spent on seeds divided by thetotal amount of crop produced.

Cost can also be measured in terms of opportunity cost. In this case the lawalso applies to societies; theopportunity cost of producing a





single unit of a good generallyincreases as a society attempts toproduce more of that good. Thisexplains the bowed-out shape of theproduction possibilities frontier.

5. Returns to scale

The marginal returns discussed referto cases when only one of manyinputs is increased (for example, thequantity of seed increases, but theamount of land remains constant). If all inputs are increased in proportion,the result is generally constant orincreased output.

As a firm in the long-run increases

the quantities of all factors employed,all other things being equal, initiallythe rate of increase in output may bemore rapid than the rate of increase ininputs, later output might increase inthe same proportion as input, thenultimately, output will increase lessproportionately than input.

See also: economies of scale

6. See also

Accelerating returns•Learning curve and Experiencecurve effects

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Diseconomies of scale, doesnot assume fixed inputs, thusdiffering from 'diminishingreturns'

•

Diminishing marginal utility,also not to be mistaken for'diminishing returns'

•

Increasing returns•Marginal value theorem•Moore's law•Opportunity cost•Tendency of the rate of profitto fall

•

7. References





Samuelson & Nordhaus,Microeconomics, 17th ed. page110. McGraw Hill 2001.

1.

Samuelson & Nordhaus,Microeconomics, 17th ed. page110. McGraw Hill 2001.

2.

Perloff, Microeconomics,Theory and Applications withCalculus page 178. Pearson2008.

3.

8. Sources

Case, Karl E. & Fair, Ray C.(1999). Principles of Economics (5th ed.). Prentice-Hall. ISBN 0-13-961905-4.

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