1. DIMINISHING MARGINAL RETURN
In economics, diminishing returns (also called diminishing marginal returns) refers to how
the marginal production of a factor of production starts to progressively decrease as the factor is
increased, in contrast to the increase that would otherwise be normally expected. According to
this relationship, in a production system with fixed and variable inputs (say factory size and
labor), each additional unit of the variable input (i.e., man-hours) yields smaller and smaller
increases in outputs, also reducing each worker's mean productivity. Conversely, producing one
more unit of output will cost increasingly more (owing to the major amount of variable inputs
being used, to little effect).
This concept is also known as the law of diminishing marginal returns or the law of
increasing relative cost.
Statement of the law
The law of diminishing returns has been described as one of the most famous laws in all of
economics.[1] In fact, the law is central to production theory, one of the two major divisions of
neoclassical microeconomic theory. The law states "that we will get less and less extra output
when we add additional doses of an input while holding other inputs fixed. In other words, the
marginal product of each unit of input will decline as the amount of that input increases holding
all other inputs constant."[2] Explaining exactly why this law holds true has sometimes proven
problematic.
Diminishing returns and diminishing marginal returns are not the same thing. Diminishing
marginal returns means that the MPL curve is falling. The output may be either negative or
positive. Diminishing returns means that the extra labor causes output to fall which means that
the MPL is negative. In other words the change in output per unit increase in labor is negative
and total output is falling.[3]
History

2. This section requires expansion.
The concept of diminishing returns can be traced back to the concerns of early economists such
as Johann Heinrich von Thünen, Turgot, Thomas Malthus and David Ricardo. However,
classical economists such as Malthus and Ricardo attributed the successive diminishment of
output to the decreasing quality of the inputs. Neoclassical economists assume that each "unit" of
labor is identical = perfectly homogeneous. Diminishing returns are due to the disruption of the
entire productive process as additional units of labor are added to a fixed amount of capital.
Karl Marx developed a version of the law of diminishing returns in his theory of the tendency of
the rate of profit to fall, described in Volume III of Capital.
Examples
Suppose that one kilogram of seed applied to a plot of land of a fixed size produces one ton of
crop. You might expect that an additional kilogram of seed would produce an additional ton of
output. However, if there are diminishing marginal returns, that additional kilogram will produce
less than one additional ton of crop (ceteris paribus). For example, the second kilogram of seed
may only produce a half ton of extra output. Diminishing marginal returns also implies that a
third kilogram of seed will produce an additional crop that is even less than a half ton of
additional output, say, one quarter of a ton.
In economics, the term "marginal" is used to mean on the edge of productivity in a production
system. The difference in the investment of seed in these three scenarios is one kilogram —
"marginal investment in seed is one kilogram." And the difference in output, the crops, is one ton
for the first kilogram of seeds, a half ton for the second kilogram, and one quarter of a ton for the
third kilogram. Thus, the marginal physical product (MPP) of the seed will fall as the total
amount of seed planted rises. In this example, the marginal product (or return) equals the extra
amount of crop produced divided by the extra amount of seeds planted.

3. A consequence of diminishing marginal returns is that as total investment increases, the total
return on investment as a proportion of the total investment (the average product or return)
decreases. The return from investing the first kilogram is 1 t/kg. The total return when 2 kg of
seed are invested is 1.5/2 = 0.75 t/kg, while the total return when 3 kg are invested is 1.75/3 =
0.58 t/kg.
This particular example of Diminishing Marginal Returns in formulaic terms: Where D =
Diminished Marginal Return, X = seed in kilograms, and = crop yield in tons gives us:
Substituting 3 for X and expanding yields:

4. Another example is a factory that has a fixed stock of capital, or tools and machines, and a
variable supply of labor. As the firm increases the number of workers, the total output of the firm
grows but at an ever-decreasing rate. This is because after a certain point, the factory becomes
overcrowded and workers begin to form lines to use the machines. The long-run solution to this
problem is to increase the stock of capital, that is, to buy more machines and to build more
factories.
Returns and costs
There is an inverse relationship between returns of inputs and the cost of production. Suppose
that a kilogram of seed costs one dollar, and this price does not change; although there are other
costs, assume they do not vary with the amount of output and are therefore fixed costs. One
kilogram of seeds yields one ton of crop, so the first ton of the crop costs one extra dollar to
produce. That is, for the first ton of output, the marginal cost (MC) of the output is $1 per ton. If
there are no other changes, then if the second kilogram of seeds applied to land produces only
half the output of the first, the MC equals $1 per half ton of output, or $2 per ton. Similarly, if
the third kilogram produces only ¼ ton, then the MC equals $1 per quarter ton, or $4 per ton.
Thus, diminishing marginal returns imply increasing marginal costs. This also implies rising
average costs. In this numerical example, average cost rises from $1 for 1 ton to $2 for 1.5 tons
to $3 for 1.75 tons, or approximately from 1 to 1.3 to 1.7 dollars per ton.
In this example, the marginal cost equals the extra amount of money spent on seed divided by the
extra amount of crop produced, while average cost is the total amount of money spent on seeds
divided by the total amount of crop produced.
Cost can also be measured in terms of opportunity cost. In this case the law also applies to
societies; the opportunity cost of producing a single unit of a good generally increases as a
society attempts to produce more of that good. This explains the bowed-out shape of the
production possibilities frontier.

5. Returns to scale
The marginal returns discussed refer to cases when only one of many inputs is increased (for
example, the quantity of seed increases, but the amount of land remains constant). If all inputs
are increased in proportion, the result is generally constant or increased output.
As a firm in the long-run increases the quantities of all factors employed, all other things being
equal, initially the rate of increase in output may be more rapid than the rate of increase in inputs,
later output might increase in the same proportion as input, then ultimately, output will increase
less proportionately than input.