Law of Diminishing Marginal Returns

By ADAM HAYES

Reviewed By MARGARET JAMES

Updated Aug 24, 2020

What Is the Law of Diminishing Marginal Returns?

The law of diminishing marginal returns is a theory in economics that predicts
that after some optimal level of capacity is reached, adding an additional factor of
production will actually result in smaller increases in output.

For example, a factory employs workers to manufacture its products, and, at

some point, the company operates at an optimal level. With all other production
factors constant, adding additional workers beyond this optimal level will result in
less efficient operations.

The law of diminishing returns is related to the concept of diminishing marginal

utility. It can also be contrasted with economies of scale.

KEY TAKEAWAYS

 The law of diminishing marginal returns states that adding an additional

factor of production results in smaller increases in output.
 After some optimal level of capacity utilization, the addition of any larger
amounts of a factor of production will inevitably yield decreased per-unit
incremental returns.
 For example, if a factory employs workers to manufacture its products, at
some point, the company will operate at an optimal level; with all other
production factors constant, adding additional workers beyond this optimal
level will result in less efficient operations.
Volume 75%

1:12
Law of Diminishing Marginal Returns
Understanding the Law of Diminishing Marginal Returns
The law of diminishing marginal returns is also referred to as the "law of
diminishing returns," the "principle of diminishing marginal productivity," and the
"law of variable proportions." This law affirms that the addition of a larger amount
of one factor of production, ceteris paribus, inevitably yields decreased per-unit
incremental returns. The law does not imply that the additional unit decreases
total production, which is known as negative returns; however, this is commonly
the result.

The law of diminishing marginal returns does not imply that the additional unit
decreases total production, but this is usually the result.

The law of diminishing returns is not only a fundamental principle of economics,

but it also plays a starring role in production theory. Production theory is the
study of the economic process of converting inputs into outputs.

History of The Law of Diminishing Returns

The idea of diminishing returns has ties to some of the world’s earliest
economists, including Jacques Turgot, Johann Heinrich von Thünen, Thomas
Robert Malthus, David Ricardo, and James Anderson.1 2 The first recorded
mention of diminishing returns came from Turgot in the mid-1700s.3

Classical economists, such as Ricardo and Malthus, attribute successive

diminishment of output to a decrease in the quality of input. Ricardo contributed
to the development of the law, referring to it as the "intensive margin of
cultivation."4 5 Ricardo was also the first to demonstrate how additional labor
and capital added to a fixed piece of land would successively generate smaller
output increases.6

Malthus introduced the idea during the construction of his population theory. This
theory argues that population grows geometrically while food production
increases arithmetically, resulting in a population outgrowing its food
supply.7 Malthus’ ideas about limited food production stem from
diminishing returns.

Neoclassical economists postulate that each “unit” of labor is exactly the same,
and diminishing returns are caused by a disruption of the entire production
process as extra units of labor are added to a set amount of capital.

Diminishing Marginal Returns vs. Returns to Scale

Diminishing marginal returns are an effect of increasing input in the short-run,
while at least one production variable is kept constant, such as labor or capital.
Returns to scale, on the other hand, are an impact of increasing input in all
variables of production in the long run. This phenomenon is referred to as
economies of scale.
For example, suppose that there is a manufacturer that is able to double its total
input, but gets only a 60% increase in total output; this is an example of
decreasing returns to scale. Now, if the same manufacturer ends up doubling its
total output, then it has achieved constant returns to scale, where the increase in
output is proportional to the increase in production input. However, economies of
scale will occur when the percentage increase in output is higher than the
percentage increase in input (so that by doubling inputs, output triples).

Compete Risk Free with $100,000 in Virtual Cash

Put your trading skills to the test with our FREE Stock Simulator. Compete with
thousands of Investopedia traders and trade your way to the top! Submit trades
in a virtual environment before you start risking your own money. Practice trading
strategies so that when you're ready to enter the real mar