Law of Diminishing Returns

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The law of diminishing returns states that after a certain point (called the point of diminishing returns), additional input to a system of production will produce less and less output. This law has been around for centuries and has been discussed at length by such eminent economists as Malthus and Marx. It is widely considered to be one of the fundamental laws of economics.

Pertinent Examples

If a handful of seeds produces a ton of crops, two handfuls of seed may produce two tons. There will come a point, however, when additional handfuls of seed produce less and less increases in production. The same can be said for fertilizer and for field workers. There will come a point in each case when increasing the input units (seed, fertilizer and workers) will produce smaller and smaller increases in crop production. Similarly, increases in workers or in square footage will show a decrease in factory output after some point. The law of diminishing returns even shows up in places, such as skill acquisition and sports training. In both places, a change in skill level is more noticeable at the beginning than later although training stays constant.

Fundamental Principle

The law of diminishing returns appears under different names although the fundamental underlying principle is the same. It is also known as diseconomies of scale, diminishing marginal utility, law of decreasing returns and the law of variable proportions. Karl Marx called it the "tendency of the rate of profit to fall." In areas associated with skill acquisition, the law is often known as "arrested progress." This profusion of names makes it seem as if there are several laws of diminishing returns. There is only one: at some point, increases in raw materials produce smaller and smaller increases in production.

Point of Diminishing Returns

The point of diminishing returns is notoriously hard to identify--except through experimentation. Economists have tried to develop a formula or a set of calculations for finding the point in a proposed project--where experimentation is not an option. They have universally concluded that this point is a characteristic of the particular system and not controlled by a general equation. An example of how this point can be dependent on the nature of the system is found in the fertilizer example. Additional fertilizer increases crop yield until the concentration of fertilizer becomes toxic--then production declines drastically. This same effect can be seen with any medicine or health supplement; often the only difference between a medicine and a poison is the dose. This observation, however, has no parallel in factory production or skill acquisition. The point of diminishing returns is highly dependent on the nature of the system.