Law of Diminishing Marginal Returns

Loading the player...

What is the 'Law of Diminishing Marginal Returns'

The law of diminishing marginal returns is a law of economics that states an increasing number of new employees causes the marginal product of another employee to be smaller than the marginal product of the previous employee at some point.

For example, a factory employs workers to manufacture its product. As long as all other factors of production stay the same, at one point, each supplementary worker generates less output than the worker before him. Thus, each worker who follows provides smaller and smaller returns. If the factory continues to add new workers, it eventually becomes so cramped that additional workers hinder the efficiency of other employees, thereby decreasing the factory’s production.

BREAKING DOWN 'Law of Diminishing Marginal Returns'

The law of diminishing marginal returns goes by a number of different names, including law of diminishing returns, principle of diminishing marginal productivity and law of variable proportions. This law affirms that the addition of a larger amount of one factor of production, while all others remain constant, identified by the Latin term “ceteris paribus,” inevitably yields decreased per-unit incremental returns. The law does not imply the addition of the factor decreases total production, otherwise known as negative returns; however, this commonly happens.

Origins

The idea of diminishing returns has ties back to some of the world’s earliest economists including Jacques Turgot, Johann Heinrich von Thünen, Thomas Robert Malthus, David Ricardo and James Steuart.

The first recorded expression of diminishing returns came from Turgot sometime in the mid-1700s. Classical economists, such as Ricardo and Malthus, attribute successive diminishment of output to a decrease in quality of input. Ricardo contributed to the development of the law, referring to it as the "intensive margin of cultivation." He was the first to demonstrate how additional labor and capital to a fixed piece of land would successively generate smaller output increases. Malthus introduced the idea during the construction of his population theory. This theory argues that population grows geometrically while food production increases arithmetically, resulting in a population outgrowing its food supply. Malthus’ ideas about limited food production stem from diminishing returns.

Neoclassical economists take the position that each “unit” of labor is exactly the same, and diminishing returns are caused by a disruption of the entire production process as extra units of labor are added to a set amount of capital.

Production Theory

The law of diminishing returns is not only a fundamental principle of economics but also plays a starring role in production theory. Production theory is the study of the economic process of converting inputs into outputs.

RELATED TERMS
  1. David Ricardo

    A classical economist known for his Iron Law of Wages, labor ...
  2. Law Of Diminishing Marginal Utility

    The Law Of Diminishing Marginal Utility is a law of economics ...
  3. Thomas Malthus

    An 18th-century British philosopher and economist famous for ...
  4. Law Of Diminishing Marginal Productivity

    An economic principle that states that while increasing one input ...
  5. Marginal Revenue Product - MRP

    The change in revenue that results from the addition of one extra ...
  6. Marginal Revenue - MR

    The increase in revenue that results from the sale of one additional ...
Related Articles
  1. Markets

    Law Of Diminishing Marginal Productivity

    The law of diminishing marginal productivity states that increasing one variable may initially increase output, but eventually leads to a diminishing rate of return.
  2. Investing

    More is Less: Diminishing Marginal Returns

    In formal economic terms, the law of diminishing marginal returns states that as the number of new employees increases, the marginal product of an additional employee will at some point be less ...
  3. Markets

    Explaining Marginal Revenue Product

    Marginal revenue product (MRP) accounts for the change in revenue that results from the addition of one extra unit, keeping all other factors equal.
  4. Markets

    Understanding Marginal Cost of Production

    Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit.
  5. Markets

    Understanding Marginal Analysis

    Marginal analysis is the process of comparing a one-unit incremental cost increase of an activity with a corresponding increase in benefits.
  6. Markets

    What's Behind the Decline in Productivity Numbers? 

    There are several theories and hypotheses about low productivity numbers in the American economy. This article examines some of them.
  7. Markets

    Does a Shorter Work Week Lead to Greater Productivity?

    While technology has significantly increased labor productivity, institutional changes, such as a shorter work week, could also be very productive.
  8. Entrepreneurship & Small Business

    3 Reasons to Develop an Employee Handbook for Your Small Business

    Learn how a small business can benefit from an employee handbook covering labor laws, codes of conduct, leave policies and media relations.
  9. Markets

    Factors Of Production

    Factors of production is an economic term describing the general inputs used to produce goods and services to make a profit. Under the classical view of economics, the factors of production consist ...
  10. Personal Finance

    Hiring? Regulations Small Businesses Need to Know

    When a small business becomes an employer, it has new responsibilities. Make sure you familiarize yourself with regulatory requirements.
RELATED FAQS
  1. Does technology follow the law of diminishing marginal returns?

    Learn how workers in the technology industry are affected by the law of diminishing marginal returns, and note the ways that ... Read Answer >>
  2. Does the law of diminishing marginal returns only apply to labor?

    Learn more about how the law of diminishing returns is used by economists and businesses. Find out more about the laws of ... Read Answer >>
  3. What's the difference between diminishing marginal returns and returns to scale?

    Understand the main differences between the law of diminishing marginal returns and the concept of returns to scale through ... Read Answer >>
  4. How can you calculate diminishing marginal returns in Excel?

    Learn more about production costs and applying the law of diminishing marginal returns using Excel. Find out more about how ... Read Answer >>
  5. How does the law of diminishing returns affect marginal revenue?

    Find out how the economic law of diminishing returns affects a business' marginal revenue, eventually reducing the effectiveness ... Read Answer >>
  6. Is there any way to reverse the law of diminishing marginal returns?

    Learn more about how consumer spending, supply and demand impact production decisions. Find out more about the law of diminishing ... Read Answer >>
Hot Definitions
  1. Duration

    A measure of the sensitivity of the price (the value of principal) of a fixed-income investment to a change in interest rates. ...
  2. Dove

    An economic policy advisor who promotes monetary policies that involve the maintenance of low interest rates, believing that ...
  3. Cyclical Stock

    An equity security whose price is affected by ups and downs in the overall economy. Cyclical stocks typically relate to companies ...
  4. Front Running

    The unethical practice of a broker trading an equity based on information from the analyst department before his or her clients ...
  5. After-Hours Trading - AHT

    Trading after regular trading hours on the major exchanges. The increasing popularity of electronic communication networks ...
  6. Omnibus Account

    An account between two futures merchants (brokers). It involves the transaction of individual accounts which are combined ...
Trading Center