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LAW OF DIMINISHING MARGINAL RETURNS

LETTER OF ACKNOWLEDGMENT

LAW OF DIMINISHING MARGINAL RETURNS

Introduction ........................................................................................................... 3 Law of variable proportion......................................................................................3 Law Of Diminishing Returns ....................................................................................4 Assumptions ...........................................................................................................4 Total product curve.................................................................................................6 Average & marginal product curve.7 Another company example..8 Relation with agriculture..9 Importance10 Conclusion11

LAW OF DIMINISHING MARGINAL RETURNS

INTRODUCTION:
LAW OF VARIABLE PROPORTIONS:
A basic question that arises before every producer is the ratio of proportion in which he should combine the inputs. In this regard a number of possible options exist. He tries to choose the best. However the choice depends upon the period of time available. In short period he can only change the variable factors as fixed factors such as plant size and building cannot be changed.

STATEMENT: As more and more units of factor of production are added to fixed factors, the total product rises, at first more in proportion to increase in variable factor, then less in proportion and then finally decreases EXPLANATION:
This law says that if one variable factor is increased keeping other constant, marginal product will first increase but after reaching to maximum, it will start decreasing and finally becomes negative. According to this law, with increase in variable factor the production of a firm does not increase at a uniform rate. The law of variable proportion has three phases: INCREASING RETURNS: In many cases the increase in variable factor increases the total output. This phase does not last long and soon diminishing returns starts. DECREASING RETURNS: If increase in variable factor continues, the marginal product starts decreasing .this phase last longer. Every economic activity comes under this phase. NEGATIVE RETURNS: When a business experience decreasing return and the quantity of variable factor is further increased, the marginal product becomes negative. But the most important phase of the law is diminishing marginal returns. ECONOMICS TERM REPORT

LAW OF DIMINISHING MARGINAL RETURNS

MARGINAL RETURN:
As the term marginal means additional, marginal return refers to the additional output by increase in one unit of variable input, while all other are kept constant

LAW OF DIMINISHING MARGINAL RETURNS:

The term return of a factor means the product of a factor in physical units. When in a process of production, the phase of increasing return ended, the phase of diminishing returns start. This happens when the points of optimum combination of factors have been crossed. This law is the third and the most important phase of the law of variable proportion. This famous law was first written about by a Frenchman, Anne Robert Jacques Turgot and then alluded to by Thomas Malthus in his Essay on the Principle of Population.

STATEMENT:
During a process of production, if one factor is made variable with other factors are held constant, the marginal product firstly increase s and after reaching a maximum stats decreasing. The decreasing phase is named as diminishing returns The law of diminishing returns applies only to short run situations, in which the firm employs pore of one input and maintains a constant quantity of all other inputs.

ASSUMTIONS:
To explain this law, we will take the following assumptions: The time period available is short run Labor is variable , while all other factors are constant Price of variable factor does not change. State of technology will remain the same All units of variable factors are homogeneous We will consider only two factors labor and land and will ignore the other two. ECONOMICS TERM REPORT

LAW OF DIMINISHING MARGINAL RETURNS

DIAGRAMMATIC REPRESENTATION:
Let us assume that we are talking about an agriculture firm, whose land is fixed which is 20 acres. But number of labor is variable.

Workers(units variable factor)

Total Product(TP)

Average Product (AP) TP/worker

20 20 20 20 20 20 20 20 20

0 1 2 3 4 5 6 7 8

0 6 14 24 32 38 42 44 44

6 8 10 8 6
Diminishing

6 7 8 8 7.6
returns

4 2 0

7 6.2 5.5

20

42

-2

4.8

LAW OF DIMINISHING MARGINAL RETURNS

If no labor is applied, land and capital produce nothing. When first worker works on land, its output is 6 units. When a second worker is added, division of work became possible and efficiency of labor increases. Up to third worker, marginal product is rising but after that it goes on falling. As more and more labor is applied, land and capital become scarce compared to labor. So, additional labor is not properly utilized. They do not add much production because enough land is not available to work at. There is over crowding on same land. The result is fall in marginal product.

When the above quantities are plotted on graph, we get following curves.

total product curve

50 total output 30 40

output 20 0 0 10

5 labor

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LAW OF DIMINISHING MARGINAL RETURNS

EXPLANATION: If we put labor on x-axis and total output on y-axis, we will get the total product curve. This curve clearly shows that from 1st till 3rd worker, total product is rising but after the 3rd worker it start diminishing, which means that these worker are contributing very less to the total output thats why

there is a little increase, and finally with the arrival of 9th worker, it came into negative, which means that the 9th worker is doing nothing. His addition has resulted in a fall in total output. We have now reached the point where 'too many cooks spoil the broth', as the saying goes.

50

40

30

TP, MP, AP

10

0 0 2 4 6 8 10

-10

workers

LAW OF DIMINISHING MARGINAL RETURNS EXPLANATION:

Notice that the point at which diminishing marginal returns sets in is to the left of the point where

diminishing average returns begins. Also, the total product keeps rising even though the marginal, and the average, product is falling. This is not hard to understand. Just because the marginal product is falling, it is still positive. Hence, these extra workers may well be adding less than previous workers, but they are still contributing to the grand total. Total product keeps rising, albeit at a diminishing rate. It is only when the marginal product is negative; with the addition of the ninth worker that total product starts to fall. Finally, notice that the marginal product curve cuts the average product curve at its highest point, where it is momentarily flat. It is important that you understand why this happens because this concept is applied to the cost and revenue curves.

ANOTHER EXAMPLE:
To illustrate the universality of the law, consider the production of a real company, Super Deluxe TexMex Gargantuan Tacos (with sour cream and jalapeno peppers). The table below presents the hourly production of Gargantuan Tacos as Waldo's TexMex Taco World employs different quantities of labor, the key variable input for short-run taco production. LABOUR 0 1 2 3 4 5 6 7 8 9 10 TOTAL PRODUCT 0 20 50 75 95 110 120 125 125 120 110 MARGINAL PRODUCT 0 20 20 25 20 15 10 5 0 -5 -10

LAW OF DIMINISHING MARGINAL RETURNS

EXPLANATAION: For the first two workers marginal product actually increases. This reflects increasing and commonly results when the variable input is able to make increasingly effective use of a given fixed input. For the third worker on, however, marginal product decreases. This reflects decreasing marginal returns and the law of diminishing marginal returns. The marginal product of the third worker is 25 tacos, compared to 30 tacos for the second worker. The marginal product of the fourth worker then

declines to 20 tacos. For the fifth worker, the marginal product falls to 15. For each subsequent worker, the marginal product declines. Marginal product eventually reaches zero for the eighth worker and even declines for the ninth and tenth workers. The decreasing values of marginal product exhibited for taco production by Waldo's TexMex Taco World reflect the law of diminishing marginal returns.

DIMINSHING RETURN IN AGRICULTURE:

Law of diminishing marginal utility directly applies to the agricultural production. A farmer has to decide that how much to farm. The answer is simple, the more he spent to farm he more money he will make. He can also gain profit by hiring more workers because two people working on a farm ten hours per day obviously produces more than a one person do in ten hours per day alone. However, this rule only applies to the extent that work is available. The farmer will reach a point where all field have been planted, hail bailed, and livestock taken care of. If the farmer continued to add workers production would decrease because additional workers would not have any work to do. Johnson states, "Marginal returns to each successive increment of labor input get smaller and smaller and ultimately turn negative" The law of diminishing marginal utility was first stated in connection with the non-proportional increase of output in agriculture. It was thought that some factors like sunshine and weather conditions are determined by nature, so any increase in labor or fertilizer cannot increase production in the same proportion. However, now it is felt that law of diminishing return has universal application. No matter what the situation, adding additional resources will produce an increasing benefit, however, there is a ECONOMICS TERM REPORT

LAW OF DIMINISHING MARGINAL RETURNS

point where the benefit decreases. Law of diminishing returns gives us the tools to understand and

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predict these benefits to maximize our returns.it is the scarcity of some factors in relation to a factor, which is the root cause of the law. The law of diminishing return is as universal as law of life is itself.

PRACTICAL IMPORTANCE:The law of diminishing marginal returns has much more practical importance and it is supported by empirical study. If law of diminishing marginal return did not exist, the whole population could have been fed by growing crops on a tiny piece of land by applying more and more amount of capital and labor. This also forms the base for the number of economic doctrine such as MALTHUSIAN theory of population, Richardian theory of rent and marginal productivity theory. This law explains why (AC) average cost and marginal cost (MC) curves of a firm rise after touching a minimum. It also provides the answer of why the supply curve has positive slope The essence
of this explanation is that the supply price that sellers are willing and able to receive for a good depends on the production cost. If the production cost increases, then the sellers need a higher supply price. Because the marginal product of a variable input declines with greater production, more of the variable input is needed, which increases production cost.

This law also explains the phenomenon of law of increasing cost.

This law explains the engineering aspect of production. The reason for nonproportional change in output is that different factors of production are not perfect substitutes for each other.

CONCLUSION:

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LAW OF DIMINISHING MARGINAL RETURNS

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RWhile the law of diminishing marginal returns pops up throughout the study of economics,
it is essential to an understanding of supply and the law of supply. It provides a bit of key insight into the question: "Why does the supply curve have a positive slope?" The essence of this explanation is that the supply price that sellers are willing and able to receive for a good depends on the production cost. If the production cost increases, then the sellers need a higher supply price. Because the marginal product of a variable input declines with greater production, more of the variable input is needed, which increases production cost. This law of diminishing marginal returns is the counterpart of the law of diminishing marginal utility. As the law of diminishing marginal utility offers an explanation for the law of demand and the negative slope of thedemand curve, the law of diminishing marginal returns offers an explanation for the law of supply and the positive slope of the supply