Diminishing Returns

Topics: Real number, Addition, Economics Pages: 8 (2323 words) Published: August 17, 2010
Diminishing returns
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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. Contents[hide] * 1 Statement of the law * 2 History * 3 Examples * 4 Returns and costs * 5 Returns to scale * 6 See also * 7 References * 8 Sources| [edit] 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] [edit] History

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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. [edit] 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...
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