Diminishing returns

2 Diminishing marginal returns

In economics, diminishing returns (also called law

of diminishing returns,[1][2] law of variable proportions,[3] principle of diminishing marginal productivity,[2] or diminishing marginal returns[4] ) is
the decrease in the marginal (incremental) 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 ("ceteris paribus"), will
at some point yield lower incremental per-unit returns.[5]
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
increasingly more fertilizer improves the yield by 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
oor. At some point, adding more workers causes problems such as workers getting in each others way or frequently nding 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 eectively.[6]
The law of diminishing returns is a fundamental principle of economics.[5] It plays a central role in production
theory.[7]

As labor usage increases from L1 to L2 , total output (measured

vertically in the top graph) increases by the amount shown. But if
labor usage is increased by the same amount again, output goes
up by less, implying diminishing marginal returns to the use of
labor as an input. The marginal product of labor (measured
vertically in the bottom graph) is diminishing everywhere to the
right of point A.

History

The concept of diminishing returns can be traced back

to the concerns of early economists such as Johann Heinrich von Thnen, Jacques Turgot, Adam Smith,[8] 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 xed amount of capital. The law of diminishing returns remains an important consideration in farming.

The dening feature of diminishing marginal returns is

that as total investment increases, the total return on investment as a proportion of the total investment (the average product or return) 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 formu1
additional
laic terms, the i th kg of seeds produces 2i1
1

6 SOURCES

tons of crop. The return from investing the rst 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:
X
1
1
D= X
i=1 2i1
1
where X = seed in kilograms, and 2i1
= additional crop
yield in tons, for the i th kilogram of seed.

Substituting 3 for X and expanding yields:

3
1
D = 13 i=1 2i1
(
)
1
1
1
+ 221
+ 231
= 13 211
(
)
= 31 210 + 211 + 212
(
)
= 13 11 + 12 + 14 = 1.75
3
= 0.583t/kg
Another example is a factory that has a xed stock of
capital, or tools and machines, and a variable supply of
labor. As the rm increases the number of workers, the
total output of the rm 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.

4 See also
Diminishing marginal utility, also not to be mistaken
for 'diminishing returns
Diseconomies of scale, does not assume xed inputs,
thus diering from 'diminishing returns
Economies of scale
Increasing returns
Learning curve and Experience curve eects
Marginal value theorem
Opportunity cost
Pareto principle
Submodular set function
Tendency of the rate of prot to fall
Liebigs Law of the minimum

5 References
[1] diminishing returns. dictionary.reference.com.
trieved 12 August 2014.

Re-

[2] diminishing returns. Encyclopaedia Britannica Online

Academic Edition. Encyclopdia Britannica Inc. 2014.

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 xed costs. One
kilogram of seeds yields one ton of crop, so the rst ton of
the crop costs one dollar to produce. That is, for the rst
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 rst, 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.

[3] A Glossary of Political Economy Terms; Diminishing returns, law of. auburn.edu. Auburn University. Retrieved
12 August 2014.
[4] Saiduzzaman, Selim. THE THEORY OF DIMINISHING RETURN. academia.edu. Retrieved 12 August
2014.
[5] Samuelson, Paul A.; Nordhaus, William D. (2001). Microeconomics (17th ed.). McGraw-Hill. p. 110. ISBN
0071180664.
[6] George, Henry. The Science of Political Economy. New
York: Robert Schalkenbach Foundation.
[7] Encyclopedia Britannica. Encyclopdia Britannica, Inc.
26 Jan 2013. ISBN 9781593392925.
[8] Smith, Adam. The wealth of nations. Thrifty books.
ISBN 9780786514854.

6 Sources
Case, Karl E.; Fair, Ray C. (1999). Principles of
Economics (5th ed.). Prentice-Hall. ISBN 0-13961905-4.

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