BUSINESS ECONOMICS (BUS-501)

PROJECT ASSIGNMENT

Topic: Law of Diminishing Marginal Returns

SUBMITTED TO:
Dr. Muhammad Bilal

SUBMITTED BY:

Tauseef Ahmad Hashmi (638)

Institute of Business & Management

University of Engineering and Technology Lahore
 Law of Diminishing Returns

Content:

1. Introduction
2. Historical context and origin
3. Key terms, concepts and factors involved
4. Graphical and numerical representation
5. Why does the law of diminishing returns occur?
6. Law of diminishing returns vs return to scale
7. Interconnection of law of diminishing returns with other economic principles and
concepts
8. Real-World examples
9. Implications and far-reaching impacts
10. Considerations
11. Conclusion
12. Theory
13. Research paper-1
14. Research paper-2
15. Research paper-3

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 1. Introduction:

The law of diminishing returns also known as principle of diminishing marginal returns, is an
economic principle that states that as the input of one factor of production is increased,
assuming other factors are constant, the marginal output or return will eventually decrease. In
simpler terms, there comes a point where adding more of a particular input yields progressively
smaller additional outputs.

A common example is in agriculture. If a farmer keeps adding more and more fertilizer to a
fixed amount of land, there will be an initial increase in crop yield. However, at some point,
adding more fertilizer becomes less effective, and the additional yield gained per unit of fertilizer
diminishes.

2. Historical context and origin:

The concept of diminishing returns has been around for centuries, but it was not until the 18th
century that it was formally articulated as an economic principle. The first person to mention
the concept of diminishing returns was the French economist Jacques Turgot, who wrote about
it in his 1767 work, Reflections on the Formation and Distribution of Wealth.

Turgot argued that as more and more labor is applied to a fixed amount of land, the marginal
product of labor will eventually decrease. This is because there is a limit to how much land can
be cultivated by a single worker, and as more workers are added, they will eventually begin to
get in each other's way.

Turgot's ideas were later developed by other economists, including David Ricardo, Thomas
Robert Malthus, and Edward West. Ricardo, in particular, applied the concept of diminishing
returns to the theory of rent, arguing that rent is the price paid for the use of land, and that it is
determined by the marginal productivity of land.

Malthus, on the other hand, used the concept of diminishing returns to explain his theory of
population, arguing that as populations grow, the amount of food available per person will
eventually decrease. This is because there is a limit to how much food can be produced on a
given amount of land, and as more people are added, they will eventually begin to compete for
scarce resources.

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Classical economist David Ricardo referred to the law as the intensive margin of cultivation.
He used it to show how additional labor and capital added to a fixed piece of land generates
successively smaller increases in output.

The classical economist Thomas Robert Malthus used a variation of the law of diminishing
returns in his population theory, stating that food production increases arithmetically while
populations grow geometrically, causing a population to outgrow its food supply. Both theorists
attributed diminishing returns to decreased input quality.

By contrast, neoclassical economists argue that each unit of labor is the same and that
diminishing returns occur because of limitations on the entire production process as additional
units of labor are added to a fixed amount of capital. They contend that value comes from the
consumer's perception of a product, whereas classical economists argue that value reflects
the cost of production.

The concept of diminishing returns has been used to explain a wide variety of phenomena,
including the behavior of firms, the growth of populations, and the sustainability of agriculture.
It is a powerful tool for understanding the relationship between inputs and outputs, and it has
had a profound impact on the development of economic thought.

Here are some additional details about the historical context and origin of the law of
diminishing returns:

• The concept of diminishing returns was first developed in the context of agriculture, as
economists tried to understand why agricultural output did not increase proportionally
with increases in labor input.
• The concept was later applied to other areas of economics, such as manufacturing and
production.

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 3. Key terms, concepts and factors involved:
I. Marginal Returns:

The law of diminishing returns focuses on marginal returns, which represent the additional
output or benefit gained by increasing one input while keeping other inputs constant.

II. Fixed and Variable Inputs:

In the context of the law of diminishing returns, there are typically fixed inputs (unchanged
during production) and variable inputs (can be changed). The law applies as additional units of
the variable input are added.

III. Short Run vs. Long Run:

The law of diminishing returns is often applied in the short run, where at least one factor of
production is fixed. In the long run, all factors can be adjusted, and the law may not apply in
the same way.

IV. Total Product, Average Product, and Marginal Product:

Total product is the overall output produced, average product is the output per unit of input,
and marginal product is the change in output resulting from an additional unit of input. The law
of diminishing returns is closely related to the concept of marginal product.

V. Increasing Returns:

Initially, as more units of the variable input are added, there is an increase in marginal and
average product.

VI. Diminishing Returns:

Eventually, the law sets in, and the marginal returns start to diminish, although average returns
may still be positive.

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VII. Negative Returns:

If the variable input continues to increase, there may be a point where total output decreases,
leading to negative marginal and average returns.

VIII. Optimal Input Level:

The goal for a producer is to find the optimal level of input where the marginal cost equals the
marginal revenue, maximizing profit. The law of diminishing returns helps in understanding
when this optimal point is reached.

IX. Optimal Output Level:

The optimal result - sometimes referred to as the optimal level -- is the ideal production rate,
where the maximum amount of output per units of input is possible

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 4. Graphical Representation of Law of Diminishing Returns:

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Diminishing vs. negative productivity: What's the difference

The terms diminishing marginal returns and negative productivity are similar concepts that are
marked by some differences.

Diminishing marginal returns is also referred to as diminishing marginal productivity. It refers to

a reduction in the efficiency of a production system and the successively smaller output
increases that result.

With diminishing marginal returns, the margins of output become smaller, or the same output
might be generated but at a higher cost per unit or marginal cost. Diminishing marginal returns
is not to say that the overall output is falling. Output can still increase as the variable factor
increases, but by smaller increments.

Imagine a vegetable garden with three workers. Each day they produce nine carrots between
them or three carrots per worker. When a fourth worker is hired, the group produces 11 carrots
or 2.75 carrots per worker. This is an example of diminishing marginal returns. The marginal
output increases but by a smaller factor.

Negative productivity or negative returns occurs when the output declines as the variable
factor is increased. Put another way, negative productivity deals with successively smaller
output. For example, negative productivity would be when a new system component is added
and total output decreases compared with the previously existing system.

In the gardening example, when the fourth worker is hired, daily output drops from nine carrots
to eight. This would be an example of negative productivity because the actual output
decreased.

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Total Product (TP) Curve:

Initially, the TP curve rises at an increasing rate, reflecting the stage of increasing returns.

As more units of the variable input are added, the TP curve starts to slope upward at a
decreasing rate, indicating the onset of diminishing returns.

Marginal Product (MP) Curve:

The MP curve is derived from the slope of the TP curve.

Initially, the MP curve rises, reaches a maximum point, and then starts to decline.

The point where the MP curve intersects the x-axis (variable input) represents the point of
diminishing returns.

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Average Product (AP) Curve:

The AP curve is derived by dividing TP by the quantity of the variable input.

It initially rises, reaches a maximum, and then starts to decline.

The point where the AP curve intersects the x-axis is where diminishing returns begin.

Numerical Representation:

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 5. Why Does the Law of Diminishing Returns Occur?

Understanding the law of diminishing returns is crucial for businesses, policymakers, and
individuals in making informed decisions about resource allocation and production strategies.
By recognizing the point at which diminishing returns set in, it is possible to optimize resource
usage, maximize output, and minimize costs.

The law of diminishing returns occurs due to the interplay of two primary factors:

1- Scarcity of Fixed Inputs

As more and more of the variable input is introduced, the fixed inputs become increasingly
scarce. This scarcity can manifest in various ways, depending on the context. For instance, in
agriculture, the fixed input could be land or water, which become increasingly limited as more
labor is employed to cultivate the land. Similarly, in manufacturing, the fixed input could be
machinery or equipment, which become increasingly constrained as more workers are added
to operate them.

In most production processes, there are fixed inputs (resources that cannot be easily or quickly
changed, such as machinery or land) and variable inputs (resources that can be easily
adjusted, such as labor or raw materials).

Initially, increasing the variable input while keeping the fixed input constant can lead to
increased output. However, as the variable input continues to increase, the fixed input may
become a constraint, limiting further increases in output.

2- Limits to Output:

There is a fundamental limit to the amount of output that can be produced with a given quantity
of fixed inputs. This limit arises from the nature of the production process itself. For example,
a factory with a fixed number of machines can only produce a finite amount of goods,
regardless of how many workers are assigned to operate those machines. Similarly, a farm
with a fixed amount of land can only yield a certain amount of crops, regardless of how much
labor is invested in cultivation.

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As the variable input is increased, it eventually reaches a point where it becomes increasingly
difficult to accommodate the additional units effectively. This overcrowding or congestion leads
to a decline in the marginal product of the variable input. In other words, adding more of the
variable input produces less and less additional output.

The law of diminishing returns is not a hard and fast rule; it is rather a tendency that holds true
in most production processes. The specific point at which diminishing returns set in varies
depending on the nature of the production process, the quality of the fixed inputs, and the
efficiency with which the variable input is utilized.

Several factors contribute to the occurrence of the Law of Diminishing Returns:

I. Coordination and communication challenges:

As the number of workers or other variable inputs increases, it becomes increasingly difficult
to coordinate their activities effectively. This can lead to inefficiencies, delays, and errors,
ultimately reducing the overall output.

II. Specialization and division of labor:

When the variable input is increased, it becomes more difficult to specialize and divide labor
efficiently. This can lead to duplication of effort, wasted time, and underutilization of skills,
resulting in lower output.

III. Physical constraints and limitations:

In many production processes, there are physical limitations that restrict the effectiveness of
additional variable inputs. For instance, in a factory, the space available to workers may
become limited as more workers are added, hindering their ability to move around and perform
tasks efficiently.

IV. Quality control and consistency:

As the variable input is increased, it can become more challenging to maintain quality control
and consistency. This is because managing and overseeing a larger group of workers or other
variable inputs can become more complex, potentially leading to lapses in quality and errors.

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 V. Fatigue and diminishing effort:

As workers continue to invest more time and effort, their physical and mental stamina may
decline, leading to fatigue and a decrease in productivity. This is especially true in physically
demanding tasks or situations where workers are subjected to repetitive motions.

VI. Resource Complementarity:

Some inputs may complement each other up to a certain point, but beyond that point, the
benefits of their combination may decline.

For example, adding more fertilizer to a field may initially increase crop yield, but excessive
fertilizer application may lead to nutrient imbalances and diminishing returns.

VII. Technological and Managerial Factors:

Technological and managerial factors can also influence the Law of Diminishing Returns.
Initially, improvements in technology or managerial practices may lead to increased
productivity. However, these gains may diminish as technology and management practices
approach their limits.

VIII. Resource Allocation:

Efficient resource allocation is crucial. Beyond a certain point, allocating more resources to a
particular factor may not yield proportionate increases in output.

6. Law of Diminishing Returns vs Return to Scale:

The law of diminishing returns and returns to scale are two related but different concepts.

Returns to scale:

Returns to scale refers to a proportional increase in all inputs of a production system. Returns
to scale are the effect of increasing all production variables in the long run. It is also referred
to as economies of scale.

Bakery example, if a bakery has two bakers and two ovens. When the third baker is added a
third oven would be installed as well. The baker and oven are additional factors of production
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that increase the scale of the entire production system and marginal outputs continue
increasing at a consistent rate.

7. Interconnection of law of diminishing returns with other economic

principles and concepts

The Law of Diminishing Returns is interconnected with several other economic principles and
concepts. Its relationships with these concepts help provide a more comprehensive
understanding of economic processes, resource allocation, and production efficiency. Here are
some key relationships:

I. Economies of Scale:

Economies of scale refer to the cost advantages that arise when production increases, leading
to lower average costs per unit. While economies of scale generally lead to cost reductions,
the Law of Diminishing Returns comes into play when further increases in production result in
diminishing marginal returns, causing average costs to rise again.

II. Marginal Utility:

The Law of Diminishing Returns is related to the concept of marginal utility, which describes
the additional satisfaction or benefit derived from consuming one more unit of a good or service.
Both concepts highlight diminishing returns: as more units are consumed, the additional
satisfaction or output per unit tends to decrease.

III. Opportunity Cost:

Opportunity cost is the value of the next best alternative forgone when a decision is made. The
Law of Diminishing Returns is relevant here, as it influences the decision-making process by
highlighting that allocating resources beyond a certain point may result in diminishing returns,
prompting consideration of alternative uses for those resources.

IV. Production Possibility Frontier (PPF):

The Law of Diminishing Returns is related to the PPF, which represents the maximum possible
output combinations of two goods given available resources and technology. Diminishing

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returns suggest that as more resources are allocated to one good, the opportunity cost of not
producing the other good increases.

V. Supply and Demand:

In the context of supply, the Law of Diminishing Returns influences the relationship between
the quantity supplied and the price of a good. As production increases, the additional output
may not increase proportionately, affecting the overall supply in the market and influencing the
equilibrium price.

VI. Technology and Innovation:

Advances in technology and innovation play a role in mitigating the effects of diminishing
returns. Technological progress can lead to increased productivity and efficiency, allowing for
the expansion of output without experiencing the same degree of diminishing returns.

VII. Environmental Economics:

The Law of Diminishing Returns is relevant to sustainable resource management. Overuse of

natural resources can lead to diminishing returns and environmental degradation. Concepts
like sustainable development and the efficient use of resources are closely tied to mitigating
the impact of diminishing returns.

VIII. Game Theory:

In strategic decision-making, the Law of Diminishing Returns can be considered when

analyzing the choices and actions of different players. Understanding the diminishing marginal
returns associated with certain strategies is crucial for making optimal decisions in various
competitive scenarios.

IX. Cost-Benefit Analysis:

When conducting cost-benefit analysis, the Law of Diminishing Returns influences the
assessment of additional costs and benefits. As more resources are allocated, the incremental
benefits may decline, affecting the overall cost-effectiveness of a decision or project.

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 8. Examples of Law of Diminishing Returns:
Suppose that one kilogram of seed applied to a plot of land of a fixed super-size produces one
ton of crop. I might expect that a return equals the extra amount of crop produced divided by
the extra amount of seeds planted.

A consequence 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. The return from investing the first kilogram is 1 t/kg. The total return when 2 kg of
seed are invested is 1.5/2 = 0.75 t/kg, while the total return when 3 kg are invested 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 = crop yield in tons gives us:

Substituting 3 for and expanding yields:

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Example 1: Manufacturing

Imagine a manufacturing plant that produces widgets using a combination of labor and
machinery. The plant has a fixed amount of machinery, but it can vary the number of workers
it employs. As the plant adds more workers, the total output of widgets will increase, but the
marginal product of labor will eventually decrease. This is because the fixed machinery
becomes increasingly scarce as more workers try to use it, leading to congestion and
inefficiencies.

Example 2: Education

Consider a student studying for an exam. The student has a fixed amount of time to study, but
they can vary the intensity of their studying. As the student studies more intensely, their exam
score will improve, but the marginal product of their study time will eventually decrease. This
is because the student's mental capacity becomes increasingly fatigued as they study more,
leading to diminishing returns on their effort.

In both of these examples, the law of diminishing returns occurs because there are limitations
to how effectively the variable input can be utilized given the constraints of the fixed inputs. As
a result, the marginal productivity of the variable input eventually declines.

Example 3: Fertilizer application:

A farmer applying fertilizer to their crops. The farmer has a fixed amount of land, but they can
vary the amount of fertilizer they apply. As the farmer applies more fertilizer, the crop yield will
increase, but the marginal product of fertilizer will eventually decrease. This is because the
fixed amount of land can only absorb so much fertilizer, and applying more fertilizer beyond
that point will not result in any additional yield.

Example 4: Exercise:

A person working out at the gym. The person has a fixed amount of time to exercise, but they
can vary the intensity of their workouts. As the person works out more intensely, their fitness

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level will improve, but the marginal product of their workouts will eventually decrease. This is
because the person's body becomes increasingly fatigued as they work out more intensely,
leading to diminishing returns on their effort.

Example 5: Marketing:

A company may find that increasing its advertising budget initially leads to a surge in sales, but
as the budget continues to grow, the marginal return on each additional dollar spent on
advertising diminishes. This is because the target audience becomes saturated with the
company's message, and further advertising has less impact.

A social media influencer may discover that as their follower count grows, the marginal impact
of each additional follower on their endorsements and sponsorships decreases. This is
because the influencer's reach becomes less targeted, and advertisers value the engagement
and influence of a more focused audience.

These are just a few examples of how the law of diminishing returns can be observed in the
real world. The law is a general principle that applies to any situation where there is a fixed
input and a variable input. As the variable input is increased, the marginal product of that input
will eventually decrease. This is because the fixed input becomes increasingly scarce, and
there is a limit to how much output can be produced with a given amount of fixed input.

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 9. Implications of Law of Diminishing Returns:

The Law of Diminishing Returns has several important implications across various economic
and business contexts. Understanding these implications is crucial for decision-makers,
economists, and business leaders.

Here are some key implications of the Law of Diminishing Returns:

I. Optimal Resource Allocation:

The law suggests that there is an optimal level of input usage that maximizes output efficiency.
Beyond this point, additional inputs may lead to diminishing returns. Businesses must carefully
allocate resources to achieve optimal productivity and avoid wastage.

II. Cost-Benefit Analysis:

The concept is essential in cost-benefit analysis. It encourages businesses to evaluate the

marginal costs and marginal benefits of inputs. Decision-makers need to assess whether the
additional cost of using more inputs is justified by the corresponding increase in output.

III. Production Planning:

The law influences production planning and capacity utilization. Companies must strike a
balance between utilizing existing resources efficiently and expanding capacity when
necessary. Over-expanding beyond the point of diminishing returns can lead to inefficiencies.

IV. Profit Maximization:

For profit-maximizing firms, understanding the Law of Diminishing Returns is crucial. It helps
in determining the optimal level of production and input usage that maximizes profits. Firms
need to find the point where marginal revenue equals marginal cost.

V. Agricultural Practices:

In agriculture, the law is particularly relevant. Farmers must carefully manage inputs such as
fertilizer, water, and labor to optimize crop yields. Overusing inputs may lead to diminishing
returns and increased production costs without a proportional increase in output.

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 VI. Investment Decisions:

The law impacts investment decisions, especially in industries with high capital requirements.
Investors and businesses need to consider the point at which further investment in machinery
or technology may yield diminishing returns, affecting the return on investment.

VII. Policy Implications:

Policymakers must consider the Law of Diminishing Returns when designing economic
policies. For instance, excessive government spending in certain sectors may lead to
diminishing returns if resources are not allocated efficiently.

VIII. Implications for Individuals:

The law also has implications for individuals in areas such as education, exercise, and personal
development. It suggests that there is an optimal level of effort or investment that yields the
highest returns, and that beyond that point, the marginal benefit of additional effort diminishes.
Understanding this principle can help individuals optimize their time, effort, and resources to
achieve their goals more effectively.

IX. Balancing Variable and Fixed Inputs:

The law emphasizes the need to strike a balance between variable and fixed inputs to
maximize output. Over-reliance on variable inputs, while initially increasing total output, may
eventually lead to diminishing marginal returns due to the scarcity of fixed inputs. Businesses
must carefully consider the optimal ratios between variable and fixed inputs to achieve the most
efficient production process.

X. Limits to Growth

The law underscores the existence of limits to growth, particularly in situations where fixed
inputs are scarce or constrained. It implies that there is a maximum level of output that can be
achieved, even with unlimited quantities of variable inputs. This principle is particularly relevant
in areas like agriculture, where land and water resources are finite, and increasing labor or
fertilizer inputs beyond a certain point may not yield significant additional output.

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 XI. Technology and Innovation:

In technological development, the law suggests that continuous innovation is necessary to

overcome diminishing returns. As existing technologies approach their limits, new and more
efficient technologies need to be developed to sustain growth and productivity.

XII. Human Resource Management:

In the context of human resources, the law implies that there is an optimal level of workforce
size for a given task. Adding more employees beyond this point may not result in proportionate
increases in productivity and could lead to diminishing returns.

XIII. Environmental Sustainability:

The law has implications for sustainable resource use. Overexploitation of natural resources
beyond their sustainable limits can lead to diminishing returns and long-term environmental
degradation.

Overall Significance:

The law of diminishing returns is a fundamental principle in economics that has far-reaching
implications for businesses, policymakers, and individuals. It guides decision-making in
resource allocation, production processes, and personal endeavors, emphasizing the
importance of efficiency, balance, and recognizing the limits of growth. By understanding the
law of diminishing returns, individuals and organizations can make informed choices that
maximize output, conserve resources, and achieve sustainable growth.

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 10. Consideration:

Small business owners often buy into the fallacy that increasing the use of variable economic
resources adds value to their business. Owners fail to recognize that their current business
operations may not be efficient enough to handle this increase in economic resources. Older
production facilities and equipment may also be unable to transform raw materials into valuable
consumer products. Older production equipment can be a bigger production problem than the
lack of direct materials and production labor.

11. Conclusion:

In conclusion, the Law of Diminishing Returns is a fundamental economic concept that has far-
reaching implications for various sectors and decision-making processes. As the quantity of
one input factor is increased while keeping other factors constant, the additional output or
returns eventually diminish. This principle highlights the limitations and constraints inherent in
production processes, resource allocation, and economic activities.

The Law of Diminishing Returns, while highlighting the constraints in resource use, also
encourages a holistic and strategic approach to production and resource management.
Acknowledging and incorporating this principle into decision-making processes contribute to
more sustainable, efficient, and economically viable outcomes across various domains.

References:

• Samuelson & Nordhaus. Microeconomics. 17th ed. McGraw Hill 2001.

• Case, Karl E. & Fair, Ray C. (1999). Principles of Economics (5th Ed.). Prentice-Hall.
• https://www.jstor.org/

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 12. Theory:

Law of Diminishing Marginal Return:

The classical economist Thomas Robert Malthus, in year 1815, used a variation of the law of
diminishing returns in his population theory, stating that food production increases
arithmetically while populations grow geometrically, causing a population to outgrow its food
supply. Both theorists attributed diminishing returns to decreased input quality.

By contrast, neoclassical economists argue that each unit of labor is the same and that
diminishing returns occur because of limitations on the entire production process as additional
units of labor are added to a fixed amount of capital. They contend that value comes from the
consumer's perception of a product, whereas classical economists argue that value reflects
the cost of production.

The concept of diminishing returns has been used to explain a wide variety of phenomena,
including the behavior of firms, the growth of populations, and the sustainability of agriculture.
It is a powerful tool for understanding the relationship between inputs and outputs, and it has
had a profound impact on the development of economic thought.

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 13. Research Paper#1

Title: Optimal decision making and matching are tied through diminishing return

By: Department of Neurobiology, Stanford University School of Medicine, Stanford, CA 94305

Edited by Ranulfo Romo, Universidad Nacional Autonoma de Mexico, Mexico City, D.F.,
Mexico, and approved July 3, 2017 (received for review March 1, 2017).

Variables:

• Behavior allocated at option

• Corresponding rate of the obtained reward
• Utilities

Methodology:

• Reward and Effort in Variable-Interval Schedules of Reinforcement

• Optimal Decision Making
• Matching Behavior
• Maximization-matching Relation
• Reward–Effort Contingencies for Estimated Reward Returns
• Reward–Effort Contingencies for Actual Reward Returns
• Actual reward returns
• Reward Maxima and Diminishing Returns

Conclusion:

The matching law is a way to understand how animals and humans make choices. It's been
important in describing behavior, but we haven't been sure how it connects to economic
theories that talk about maximizing benefits and why people often choose to match things.

This article explains that the reward you get depends on the effort you put in. It figures out the
conditions where matching is the best choice. Matching turns out to be the best strategy when
the rewards you get decrease as you put in more effort, a concept called the law of diminishing
returns.

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In simple terms, this means that when the returns you get from your choices start to decrease
as you work harder, using a matching strategy (where you distribute your behavior based on
the value of your options) is a smart and efficient way to make decisions. This is important
because it shows that, even though economic theories say we should always try to get the
most reward, in real life, using a simpler matching strategy can be the best and most rational
choice.

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 14. Research Paper#2

Title: The Increasing Returns to Scale CES Production Function and the Law of
Diminishing Marginal Returns

By: Stephen K. Layson

Variables:

• Capital Distribution Parameters

• Return to Scale Parameters
• Elasticity of Substitutions

Methodology:

• Asymptotic Properties of Average Products

• Asymptotic Properties of the Marginal Products
• Asymptotic Properties of the Output Elasticities

Conclusion:

The article talks about a common production function called CES and explores a special case
where things get a bit extreme, which the author calls the "explosive case." In this special
situation, when the production scale and the ability to substitute factors are both really high,
the article finds something surprising: the productivity of both labor and capital becomes
incredibly large as they increase without limit.

This is interesting because it goes against the usual idea that as you use more labor or capital,
the additional gains start to decrease (law of diminishing marginal returns). In this extreme CES
case, that law is seriously violated.

However, the article doesn't just leave it at that. It goes on to set boundaries for how much of
the overall production comes from capital. Even in this explosive case, there are limits to how
much capital's share can grow, and these limits are in line with the idea that adding more capital
should still bring smaller and smaller extra benefits, even if the overall production is going crazy.

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In simpler terms, the article looks at a specific production scenario, finds a surprising outcome
where things don't behave as expected, but then shows that even in this extreme situation,
there are still some rules about how much each factor (like labor and capital) contributes to the
total output.

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 15. Research Paper#3

Title: Retrospective: The Law of Diminishing Returns

By: Stanley L. Brue, Professor of economics, Pacific University, Washington.

Outline:

From introductory economics to theoretical papers, the law of diminishing returns is a part of
every economist's tool kit. But the evolution of this law in the history of economic analysis
reveals more complexity than is perhaps generally understood. Even among those most
responsible for its evolution, the law has been loosely defined, and many so-called "proofs" of
the law have been weak and incomplete. Moreover, those who expounded the law and its
economic implications rarely offered empirical evidence to support it. In fact, economists have
offered alternative explanations for rising short-run marginal cost curves, and other implications
of the law of diminishing returns. This last point raises an interesting question: Have economists
used the law of diminishing returns simply for convenience, or is the law fundamental to
economic analysis?

Variables:

Unit of land, H

Unit of Capital and Labor, K

Product, P

Conclusion:

Despite the imprecisions, confusions and assertions detailed here, I believe that the modern
formulation of the law of diminishing returns remains the best explanation for upward-sloping
short-run marginal cost curves and downward-sloping short-run resource demand curves.

The idea of heterogeneous scarce resources can complement the law of diminishing returns.
But heterogeneity of resources comes into play mainly when aggregates and large changes in
quantities are involved. As a nation specializes in one good, it eventually needs to use less-
substitutable resources, causing marginal costs to rise and international specialization to be

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incomplete. If enough new labor is employed in a particular industry, inferior heterogeneous
labor eventually will be required. But the idea of the law of diminishing returns continues to
apply in the case of economic decisions made by individual enterprises, which usually involve
such small quantities of constant-price inputs that they need not add those of an inferior grade.
Within the broad spectrum of heterogeneous land, capital, labor, and entrepreneurial talent,
there are important pools of resources which are essentially interchangeable. To explain
declines in marginal product (rises in marginal cost of output) as a single competitive firm with
a fixed plant employs more of these relatively interchangeable inputs, only the law of
diminishing returns is adequate.

27 | P a g e