Law of diminishing returns

(version of classical and neo classical economists)

The law of diminishing returns (also called the Law of Increasing Costs) is an important law of micro economics. The law of diminishing returns states that if an increasing amounts of a variable factor are applied to a fixed quantity of other factors per unit of time, the increments in total output will first increase but beyond some point, it begins to decline. Richard A. Bilas describes the law of diminishing returns in the following words. If the input of one resource to other resources are held constant, total product (output) will increase but beyond some point, the resulting output increases will become smaller and smaller.

The law of diminishing return can be studied from two points of view,

  1. the Law as it applies to agriculture and
  2. as it applies in the field of industry.

1. Operation of the Law in Agriculture.

1. Traditional Point of view. The classical economists were of the opinion that the law of diminishing returns applies only to agriculture and to some extractive industries, such as mining, fisheries urban land, etc. The law was first stated by a Scottish farmer as such. It is the practical experience of every farmer that if he wishes to raise a large quantity of food or other raw material requirements of the world from a particular piece of land, he cannot do so. He knows it fully that the producing capacity of the soil is limited and is subject to exhaustation. As he applies more and more units of labour to a given piece of land, the total produce no doubt increases but it increases at a diminishing rate. For example, if the number of labour is doubled, the total yield of his land will not be double. It will be less than double. If it becomes possible to increase the yield in the very same ratio in which the units of labour are increased, then the raw material requirements of the whole world can be met by intensive cultivation in a single flower-pot. As this is not possible, so a rational farmer increases the application of the units of labour on a piece of land upto a point which is most profitable to him. This is in brief, is the law of diminishing returns. Marshall has stated this law as such: As Increase in capital and labour applied to the cultivation of land causes in general a less than proportionate increase in the amount of the produce raised, unless it happens to coincide with the improvement in the act of agriculture.

This law can be made more dear if we explain it with the help, of a schedule and a curve.

Schedule

Fixed Input

Inputs of Variable
Resource

Total Produce TP
(in Tons)

Marginal product MP
(in Tons)

12 Acres

1 labour

50

50

12 Acres

2 labour

120

70

12 Acres

3 labour

180

60

12 Acres

4 labour

200.

20

12 Acres

5 labour

200

o

12 Acres

6 labour

195

-5

In the schedule given above, a firm first cultivates 12 acres of land (Fixed input) by applying one unit of labour and produces 50 tons of wheat. When it applies 2 units of labour, the total produce increases to 120 tons of wheat, here, the total output increased to more than double by doubling the units of labour. It is because the piece of land is under-cultivated. Had he applied two units of labour in the very beginning, the marginal return would have diminished by the application of second unit of labour. In our schedule┬╗ the rate of return is at its maximum when two units of labour are applied. When a third unit of labour is employed, the marginal return comes down to 60 tons of

wheat With the application of 4th unit, the marginal return goes down to 20 tons of wheat and when 5th unit is applied it makes no addition to the total output. The sixth unit decreased it. This tendency of marginal returns to diminish as successive units of a variable resource (labour) are added to a fixed resource (land), is called the law of diminishing returns. The above schedule can be represented graphically as follows.

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