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The Law of Diminishing Marginal Returns

The Law of Diminishing Marginal Returns
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  • 0:02 Too Much of a Good Thing
  • 1:15 Enough is Enough
  • 2:32 Marginal Return Curve
  • 4:37 Lesson Summary
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Lesson Transcript
Instructor: Kevin Newton

Kevin has edited encyclopedias, taught middle and high school history, and has a master's degree in Islamic law.

Ever wonder what keeps us from eating nothing but our favorite foods? Or how we determine in what order to request different goods? Much of that comes down to the law of diminishing marginal returns, which proves there is too much of a good thing.

Too Much of a Good Thing

Imagine that someone has offered you the opportunity to eat as many candy bars as you want, assuming that you pay for them and you eat them in one sitting. Chances are you'd be willing to pay well for that first candy bar - let's say two dollars. You eat it and are immediately offered another. Again, you name your own price, and eat the second bar. By the third candy bar, you may still want one, but two dollars is a little extreme now. Maybe a buck fifty is a better price? Your supplier agrees, and you eat the third one, and the fourth, and fifth, and sixth.

Each time you pay slightly less, simply because the extra candy bars no longer have the same utility, or value, as the ones before. Finally, by the time you've reached candy bar number ten, you're sick to your stomach, and may very well be thinking of paying the candy man to stop giving you chocolate! While it may feel like you're victim of a stomachache, in reality you're also victim of a very integral part of economics - the law of diminishing marginal returns. This idea states that the utility of a given item can decrease as more of it is provided.

Enough Is Enough

It's an established fact in economics that there are limits to the amount of utility that a given good can offer someone. Think about how chaotic it would be if certain goods or actions never decreased in utility. For one thing, it's doubtful there would be any candy bars.

More seriously, some people would work all the time, while others would never work. Some people would stay up late at night working, because they felt there was greater utility to be found in work than in anything, including spending time with friends and family. However, while some people may occasionally push the limits of what is healthy with their obsessions, for most of us the law of diminishing returns is applicable in all aspects of life.

Let me give you another example. Let's say instead of candy bars, it was cookies that you desired. Now everyone knows that cookies are infinitely better with milk. If not for the law of diminishing returns, the rational person would choose one or the other. However, because each additional unit of a given good has a lower price that the person is willing to pay, that means at some point the utility of a glass of milk will surpass the utility of another cookie.

Marginal Return Curve

I don't think it surprises you to hear that economists have found a way of putting all of this on a model. Called the marginal return curve, this model helps people figure out the given utility for a good. Remember that utility is often just measured as price. Let's graph that candy bar example with a chart that shows the price that you'd pay per candy bar until bar number 10.

Marginal Return Curve
marginal return curve for candy bar example

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