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Understanding Diminishing Returns

Updated on January 30, 2010

In economics, the law of diminishing returns describes a technologically determined relationship between productive resources inputs (such as land, laborers, factories, equipment, and raw materials) and output. It was stated first in the 18th century writings of economists A.R.J. Turgot in France and Thomas Malthus and David Ricardo in England. These economists utilized the law to explain changes in agricultural production arising from increasing the intensity of cultivation on one land plot. Currently, it is also known to economists as the law of variable proportions or the law of diminishing marginal production.

The law of diminishing returns assumes unchanging technology and states: when a producer augments output by employing additional units of one productive resource (for example, labor) with a fixed quantity of other resources, he will find that eventually in this process the output added by one more input unit (laborer) will be less than the output produced by the just previously added input unit. This is the stage of diminishing returns. Diminishing returns begin because the larger number of workers reduces the amount of land, machinery, equipment, and raw materials available to each worker. This stage ordinarily is preceded by a brief stage of increasing returns where each successive input unit (laborer) adds more units to output than did the immediately preceding input unit. The stage of diminishing returns ends when an additional input unit reduces total production, thus beginning the stage of negative returns.

Diminishing returns is an important economic phenomenon because it causes costs of production to rise as output is increased within a short period of time. (Over a longer period of time a producer can alter the quantity of several or all resources and avoid diminishing returns.) A producer subject to diminishing returns will produce   and   market   a   larger   output   only   if e  is  offered  a  higher  price  to  cover  his  increasing costs of production. Diminishing returns is thus the basis for the economic law of short-run supply- that is, as the price offered on a market is raised, the quantity of a commodity producers will bring to the market increases.

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