The law of diminishing returns also referred to as the law of diminishing marginal returns, states that in a production process, as one input variable is increased, there will be a point at which the marginal per unit output will start to decrease, holding all other factors constant. In other words, keeping all other factors constant, the additional output gained by another one unit increase of the input variable will eventually be smaller than the additional output gained by the previous increase in input variable. At that point, the diminishing marginal returns take effect.
Assumptions of Law of Diminishing Returns
The assumptions of the law of diminishing returns are as follows:
(i) Units of capital and labor are used as variable factors.
(ii) The prices of the factors do not change.
(iii) All units of variable factors are equally efficient.
(iv) There is no change in technique of production.
(v) Best combination of factors of production has crossed the level of optimum point.
(vi) There is no change in the fixed factor of production.
A Farmer Example of Diminishing Returns
Consider a corn farmer with one acre of land. In addition to land, other factors include quantity of seeds, fertilizer, water, and labor. Assume the farmer has already decided how much seed, water, and labor he will be using this season. He is still deciding on how much fertilizer to use. As he increases the amount of fertilizer, the output of corn will increase. It may also reach a point where the output actually begins to decrease since too much fertilizer can become poisonous.
The law of diminishing returns states that there will be a point where the additional output of corn gained from one additional unit of fertilizer will be smaller than the additional output of corn from the previous increase in fertilizer. This table shows the output of corn per unit of fertilizer:
As the farmer increases from one to two units of fertilizer, total output increases from 100 to 250 ears of corn. Therefore the marginal, or additional, ears of corn gained from one more unit of fertilizer is 150 (250 – 100). From two to three units of fertilizer, the total output increases from 250 to 425 ears of corn, a 175 marginal increase.
At what point does the law of diminishing returns set in? Look for the point at which the marginal increase is at the highest point and the next marginal increase is less. In this example, that occurs after the farmer adds the third unit of fertilizer. At three units, the marginal output in ears of corn is 175, but when the fourth unit is added, the marginal output drops to 125.
Again, this does not mean the total production starts to decrease. In fact, the total production is still increasing, as shown in the total ears of corn column. Also note that at the sixth unit of fertilizer, the farmer starts to experience negative returns, where the increase in fertilizer actually decreases the total output and the marginal output becomes negative.
Application of Law of Diminishing Returns
The law of diminishing returns has its wide application. But is especially applicable to agricultural sector. In this sector, there is the supremacy of nature plays in production corresponds to diminishing returns. Due to the following reasons, the agricultural sector is subject to law of diminishing returns.
- The natural factors have more role than human factors in agricultural sector and marginal productivity decreases.
- The sector has very wide area and supervision cannot be very effective.
- Scope of specialized machinery is limited.
- There are other limitations of seasonal nature e.g. rain, climate changes etc.
- The fertility land also declines
The application of this law is not confined to agriculture but it applies everywhere. If the industry is expanded too much, the supervision will become inefficient and costs will go up. In agriculture it sets in earlier and in industry much later. Agriculture has also increasing returns in the beginning.