Economic Law of Diminishing Returns

Defining the Law of Diminishing Returns

The hypothesis underlying the law of diminishing returns is that: if one factor of production is increased by small, constant amounts while all other factor quantities are held constant, then after some point the resulting increases in output become smaller and smaller. Before this point is reached output may increase by either constant amounts or by increasing amounts. The assumption of this law is that the units of the variable factor are identical, and that technological knowledge does not change. As the law of diminishing returns assumes at least one fixed factor, the hypothesis relates to short-term outcomes.

To illustrate the functioning of the law of diminishing returns, consider the example of a soft drink bottling facility. Assume that the facility has three bottling and capping systems, and that the output from these systems must be handled by human labor to remove the output from the production area, store the output in a holding area, and load the output for shipment to customers. If one person is required to operate each of the bottling and capping systems, additional human labor is required to handle the output unless the system is shut down while the system operator handles the output. Thus, retaining the fixed number of bottling and capping machines while

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oyed . . . the produce will not be doubled. Ricardo held, however, that although the rate of gain may diminish, rent may continued to be created through the addition of capital. Ricardo (quoted in Ekelund & Hebert, 1991, p. 126) added that, in "such case, capital will be preferably employed on the old land, and will equally create a rent; for rent is always the difference between the produce obtained by the employment of two equal quantities of capital and labour. Ricardo illustrated "that diminishing returns existed at both the intensive margin (more inputs applied to the same land) and the extensive margin (the same inputs applied to different types of land) in agricultural production (Ekelund & Hebert, 1991, p. 126). Marginal product declines as more inputs are added to each type of land. Diminishing returns to labor occur only on "the intensive margin. But total product also declines as production moves out to poorer lands. At the extensive margin, decreasing total output is due to differences in fertility" (Ekelund & Hebert, 1991, p. 127). These early developments of the law of diminishing returns applied only to production from land. "The amount of land used by the manufacturing sector was assumed to be of negligibl
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