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What is 'Law of Diminishing Marginal Returns'

The law of diminishing marginal returns states that, at some point, adding an additional factor of production results in smaller increases in output.  For example, a factory employs workers to manufacture its products, and, at some point, the company operates at an optimal level. With other production factors constant, adding additional workers beyond this optimal level will result in less efficient operations. 

BREAKING DOWN 'Law of Diminishing Marginal Returns'

The law of diminishing marginal returns is also known as the law of diminishing returns, the principle of diminishing marginal productivity, and the law of variable proportions. This law affirms that the addition of a larger amount of one factor of production, ceteris paribus, inevitably yields decreased per-unit incremental returns. The law does not imply that the additional unit decreases total production, which is known as negative returns; however, this is commonly the result.

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

Origins

The idea of diminishing returns has ties 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 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 postulate 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.

  

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