The Law of Diminishing Returns

Finance and economy are governed by various theories and laws formulated out of patterns discovered by scholars and experts in the field. One these is the Law of Diminishing Returns.

The Law of Diminishing Returns, variably known as “variable factor proportions”, “diminishing marginal return” or simply “diminishing returns”, is an economic relationship stating that each additional unit to a production system having variable and fixed inputs shall yield less output at a particular point.

Simply put, when variable factor of production is increased while others remain unchanged, there will come a point when the addition of another unit to that “increasing” factor shall result in diminishing returns and a fall in the marginal physical product.

To better understand this concept, check out this example.

In a particular of plot of land where a kilogram of seeds yields a ton of crop, one would normally assume that planting two kilograms of seeds would give him or her production output of two tons of crop. However, according to the law of diminishing returns, as long as other factors in the production of crop such as the quality of land, land area, and growing season are unchanged, the second kilogram of seed shall yield less output than the first has. Consequently, a third kilogram would produce less than the second would yield, and so on.

For the production output of the second kilogram of seeds to meet that of the first, other factors in the production must also be increased in proportion to the increase in the amount of seeds planted.