In Economics, Law of Diminishing Returns, also called Law of Variable Proportions, Diminishing Marginal Returns or Principle of Diminishing Marginal Productivity, states that the incremental (marginal) output of a production process decreases as the amount of a single factor of production is incrementally increased, while holding all other factors of production constant.
Law of Diminishing Returns Explained
A very common example is that of a set of workers assembling a vehicle on a shop floor in a production facility. Assume that the number of workers is being added one by one. When there are few workers assembling the vehicle, a new worker would result in an increased incremental output per-unit as the effectiveness of each worker would be better utilized.
But beyond a certain point, a new worker would only cramp up the existing space and start coming in the way of other workers, thus the per-unit output would start reducing. Thus each subsequent unit of output would take longer and cost more than the previous unit did.
What it Does Not Mean
The Law of Diminishing Returns does not imply that the total production output would start decreasing with each subsequent addition of a factor of production. This condition known as Negative Returns is widely experienced in practice, but it is not implied by the Law of Diminishing Returns.
What are the Factors of Production?
There are three basic resources or factors of production – Land, Labour and Capital. All three of these are required in combination to convert an input to finished goods and services.
The primary assumption is that out of the three basic factors of production, only one varies, and the other two stay constant.
Classification of Factors of Production
Factors of Production may be classified as:
Primary Factors – The Primary factors of Production are land, labour and capital goods
Secondary Factors – Materials and Energy are considered secondary factors as they are obtained from Land, Labour and Capital
The Primary Factors facilitate production but
do not end up becoming a part of the end product
do not get transformed by the production process
The above two points are not true for the Secondary Factors
Assumptions in Law of Diminishing Returns
The following are the assumptions when we describe the Law of Diminishing Returns:
Only one factor increases; all other factors of production are held constant
There is no change in the technique of production
Important Contributors to the Law of Diminishing Returns
The Law of Diminishing Returns plays a huge part in the theory of population and the theory of rent as we understand them today. Reverend Thomas Malthus (1766-1834) was one of the first economists to develop and apply the law of diminishing returns. He applied the Law of Diminishing Returns to agriculture. David Ricardo (1772-1823), a classical economist, applied the Law of Diminishing Returns to the rent of the agricultural land. Francis Edgeworth (1845-1926) was the first one to clearly distinguish between the average and marginal products of a variable resource.
Modern Applications of the Law of Diminishing Returns
A good example of the application of Law of Diminishing Returns in today’s time could be Social Media Marketing.
Many would assume that increasing the budget of a marketing campaign on the social media would lead to increased returns, but after a point of time, it could also lead to an excess of information and advertisement that may be difficult to target to a particular individual, or may lead to dissension on the part of the consumer leading him away from the product/service being advertised.