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The law of diminishing returns, also referred to as the law of diminishing marginal returns, states that in a production process, as one input variable is increased, there will be a point at which the marginal per unit output will start to decrease, holding all other factors constant. In other words, keeping all other factors constant, the additional output gained by another one unit increase of the input variable will eventually be smaller than the additional output gained by the previous increase in input variable. At that point, the diminishing marginal returns take effect.
Consider a corn farmer with one acre of land. In addition to land, other factors include quantity of seeds, fertilizer, water, and labor. Assume the farmer has already decided how much seed, water, and labor he will be using this season. He is still deciding on how much fertilizer to use. As he increases the amount of fertilizer, the output of corn will increase. It may also reach a point where the output actually begins to decrease since too much fertilizer can become poisonous.
The law of diminishing returns states that there will be a point where the additional output of corn gained from one additional unit of fertilizer will be smaller than the additional output of corn from the previous increase in fertilizer. This table shows the output of corn per unit of fertilizer:
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As the farmer increases from one to two units of fertilizer, total output increases from 100 to 250 ears of corn. Therefore the marginal, or additional, ears of corn gained from one more unit of fertilizer is 150 (250 - 100). From two to three units of fertilizer, the total output increases from 250 to 425 ears of corn, a 175 marginal increase.
At what point does the law of diminishing returns set in? Look for the point at which the marginal increase is at the highest point and the next marginal increase is less. In this example, that occurs after the farmer adds the third unit of fertilizer. At three units, the marginal output in ears of corn is 175, but when the fourth unit is added, the marginal output drops to 125.
Again, this does not mean the total production starts to decrease. In fact, the total production is still increasing, as shown in the total ears of corn column. Also note that at the sixth unit of fertilizer, the farmer starts to experience negative returns, where the increase in fertilizer actually decreases the total output and the marginal output becomes negative.
We have all been to a café where they consistently seem slammed with customers in the mornings and wonder why they don't schedule more employees for that shift. Assuming the café cannot increase in size to serve the customers, it has to rely on operating at an efficient point given the input factors that can be easily adjusted. In this case, the input factor that can change in the short run is labor.
This chart shows the total cups of coffee served and marginal coffees served as they increase the number of workers. At what point does the law of diminishing returns set in? Does this situation also experience a decrease in returns? If so, at what point and why do you think that occurs?
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After the fourth employee is added, the law of diminishing returns sets in. With four employees, they serve 350 coffees; with five, 425. Even though the output still increases, the marginal increase from four to five employees is only 75 cups of coffee; from three to four employees, the marginal increase is 125.
Therefore the law of diminishing returns sets in after the fourth employee is added (point A on the chart). In this example, negative returns occur at the sixth employee (point B). Negative returns may occur in this scenario because the café may not have enough room for six employees behind the counter, and they spend more time maneuvering around one another than making coffee, thus decreasing their productivity.
The law of diminishing returns is more applicable in the short term as opposed to a longer time line. As previously stated, the law requires that only one input variable is adjusted and all others are held constant. In the short term, this makes sense. Consider the farmer. The farmer could buy more land to increase productivity, but it can take several years to find, finance, and prepare the land. Therefore holding that variable constant makes sense in the short term but could be altered in the longer run. The same holds true for the café. In the short run, the owner can't easily increase space. Increasing space for production, however, is definitely viable in the long run.
The law of diminishing returns states that as one input variable is increased, there is a point at which the marginal increase in output begins to decrease, holding all other inputs constant. At the point where the law sets in, the effectiveness of each additional unit of input decreases. This does not mean that output decreases; output begins to increase at a decreasing rate for each additional unit of input. There can be a point at which output begins to decline; this is referred to as negative returns.
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Introduction to Macroeconomics: Help and Review17 chapters | 193 lessons | 1 flashcard set
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