Diminishing Marginal ReturnsThe Law & How It’s Defined

Written By:
Lisa Borga

What is the Law of Diminishing Returns?

The law of diminishing marginal returns, or as it’s also referred to as the law of diminishing returns, is a fundamental economic theory that is crucial for finding the right balance of factors for production within an organization.

This theory states that in any production process, no matter its nature, there is a point where the addition of one more unit of a certain factor of production while all others are equal will result in a reduced increase in output.

This makes it crucial for a business to find the point where the factors of production are optimally balanced in order to achieve the greatest efficiency.

Explaining the Law of Diminishing Marginal Returns

This law states that in the production process, there will come a point at which adding one additional production unit while keeping the other units the same will result in decreased output.

The law does not suggest that the addition of the extra unit causes decreased output, which would be considered negative returns.

But, this is often the case.

In addition to being a basic principle of economics, the law of diminishing marginal returns is also an important part of the production theory.

This theory looks at the relationship between the factors of production and the output of goods and services.

History of the Law of Diminishing Returns

The concept of diminishing returns is not new.

It has connections to some of the earliest economists, such as Thomas Robert Malthus, David Ricardo, Johann Heinrich von Thünen, and Jacques Turgot.

Diminishing returns were first mentioned by Turgot in the 1700s.

Some classical economists, including Malthus and Ricardo, believed that a decrease in the quality of inputs causes successive diminishment of output.

Ricardo helped create the law calling it the  “intensive margin of cultivation.”

He also was the first person to show how adding additional capital and labor to a fixed piece of land would result in smaller output increases over time.

Malthus presented this idea while he was constructing his population theory.

Malthus’s population theory suggested that population grows at a geometric rate while food production only increases arithmetically.

This causes a population to grow faster than its food supply.

These ideas concerning food supply come from the concept of diminishing returns.

Neoclassical economists have different views on diminishing returns.

These economists believe that each unit of labor is identical, and diminishing returns are caused by a disruption of the whole method of production as the units of labor are increased, but the amount of capital remains the same.

Diminishing Marginal Returns vs. Returns to Scale

Diminishing marginal returns occur in the short run as more units of a variable input are added to at least one fixed input.

In contrast, returns to scale happen when all production inputs are increased in the long run.

This is considered economies of scale.

An example of this would be a manufacturer who decides to increase his total inputs by 50% but ends up with a 25% increase in his total output.

This is considered decreasing returns to scale. However, if this manufacturer achieves a 50% increase in output, this would be considered constant returns to scale.

Constant returns to scale occur when a manufacturer’s increase in input is proportional to their increase in output.

If the manufacturer had found that his percentage of increase in output was greater than the percentage of increase in input, this would have meant that the manufacturer was experiencing economies of scale.

Key Takeaways

• The law of diminishing marginal returns, also known as the principle of diminishing marginal productivity, states that after a certain level of production capacity has been reached, the addition of one production unit while all others remain constant will result in a reduced output per unit.
• A classic example of this is that a farmer may increase output by hiring more workers to tend his field. However, past a point adding more workers will not help at all unless the size of the land or some other factor of production were to change.