5 Examples of The Law of Diminishing Returns

The law of diminishing returns states that a production output has a diminishing increase due to the increase in one input while the other inputs remain fixed. BusinessZeal, here, explores 5 examples of the law of diminishing returns.
BusinessZeal Staff
"Morality, like other inputs into the social process, follows the law of diminishing returns - meaning ultimately, negative returns. People can be too moral."
― Thomas Sowell, American writer and economist
Also called the law of diminishing marginal returns, the principle states that a decrease in the output range can be observed if a single input is increased over time. The word 'diminishing' suggests a reduction, and this reduction takes place due to the manner in which goods are produced. This concept is vital in economics as well as other fields of business and finance, to predict a range of outputs and their causal factors. It primarily holds true in all kinds of production, of course, but may change if the production method varies.

The main negative effect of this law is the fact that the output for an individual laborer falls, and this affects the whole process. The technique can be clearly understood through a few law of diminishing returns examples given below.
The Concept
  • As mentioned above, the law states that the extra output obtained by increasing one input, while the other inputs are constant, decreases over time.
  • In layman's language, if you increase a particular input, say, the number of employees, and you keep increasing it over a period, the work that each employee does is obviously reduced.
  • In other words, the load is less for each employee, which results in the production reducing per unit level.
  • Adopting this practice may increase the overall output, but the level of increase will be lesser, i.e., diminishing.
  • Thus, this strategy may lead to an overall decrease in the marginal product, and diminishing marginal returns.
  • Also remember, to increase production, one needs to increase the cost and other inputs, simultaneously.
  • There is no particular formula to calculate this value; however, you can use parameters like cost of production and average output for a particular value of input, and by adding an extra input each time, you will come to the point where the level of productivity keeps deceasing.
  • Another important point you need to remember is that this law applies only in the short run, because the input factors do not remain fixed for a long time.
  • This theory is represented in the form of three curves, called marginal product curve, total product curve, and average product curve.
  • The marginal product curve shows how the production of the product changes when one input unit is added.
  • The total product curve show the amount of production per input (every input, like time and labor).
  • And, the average product curve shows the average production by the work force.
  • Thus, the average productivity is hampered due to diminishing marginal returns.
Example I
  • Consider the classic economics example of farming.
  • Let a farmer select a couple of farmhands to help him in his tasks, like tilling the land, sowing seeds, watering, etc.
  • The tasks will be divided equally among the two farmhands.
  • After some time, the farmer selects two more farmhands for the same job.
  • Over time, the farmer has a sufficient amount of work force, and consequently, the work for each farmhand is significantly reduced.
  • Also, remember that other factors are constant, i.e, after some time, you will have the farmhands fighting with one another for raw materials.
  • This leads to an overall decrease in the output and productivity, due to the reduced efficiency of the workforce.
Example II
  • Consider a simple real-life example. Let's say, you plan to read 30 pages of a novel in 1 hour.
  • In this scenario, the inputs are the time, the number of pages per hour, and your efficiency in understanding the story.
  • So now, let's assume you plan to increase the number of pages. Let us assume, you start by reading 30 pages for the first hour, then, 40 pages for the second hour, and so on.
  • As the hours pass, you may finish the book sooner than the set target time, but your efficiency will be reduced, your understanding of the novel will probably be incomplete.
  • Thus, by increasing per unit of input, the output is increasing at a decreasing rate.
  • Another easy example would be that of eating your favorite chocolate cake.
  • When a small piece is brought for you, you finish it immediately. When another piece is brought, you still want more, and you eat that up too.
  • As more and more pieces are brought, the speed at which you eat reduces. You start eating slower than before and also with less enthusiasm, since your craving has been satisfied and your stomach is full as well.
  • This is a classic domestic-life example.
Example III
  • Take the example of a small business. Let us assume, there is a small cafe that hires 2 chefs to prepare special breakfast dishes.
  • As time passes, 2 more chefs are hired.
  • The work, materials, equipment, etc., thus get evenly distributed.
  • The hiring process continues, and the work per chef consequently gets reduced.
  • Also, there will be an ever-increasing conflict for raw materials like the ingredients, cookware, etc.
  • The work might get slowed down, and even though the number of dishes might increase, the overall production rate could be very slow.
Example IV
  • Consider the farming scenario again.
  • Let's say, a farmer uses 1 small can of fertilizer for 1 acre of his farming land. So then, if he has 1,000 acres, he will use 1,000 small cans, which we will assume to be 500 large cans of fertilizer per 1,000 acres.
  • If he increases the dosage per 1,000 acres, he will have a faster growth for the crops for that month.
  • Encouraged, he might increase the fertilizer supply a bit further. Again, he might have an increased output.
  • If he continues this on a regular basis, though, the crops might get spoiled due to excess fertilizer.
  • Also, we assume here that other inputs like water supply and the like, are being kept constant.
  • Thus, even if the production increases, the increase takes place at a very slow rate, harming the overall production.
Example V
  • Consider an scenario from a software company.
  • Assume that a programmer writes 100 lines of code per day.
  • In order to finish the development phase before the deadline, the company will hire more employees.
  • Over a period, the number of lines of code written will increase, but this factor does not consider other matters, like the productivity per employee, time taken per unit, efficiency of the machines, etc.
  • Therefore, even though the number of lines of code would increase and the deadline would be met, factors like inefficiency, overcrowding, fatigue, supervision of the management on a larger workforce, etc., eventually end up hampering the production.
  • Thus, the production increases, but at an excruciatingly slow pace.
Many economists have different views regarding the law of diminishing returns. The principle is important though, because it forms the basis of the assumption that the marginal cost of an organization (in the short run) will increase as the number of output units increase. Also, this law is said to be parallel to the law of demand and supply, which predicts that the number of units that an organization wishes to sell is directly proportional to the increasing cost price of the product. All in all, it is essential for economists and aspiring entrepreneurs to know all about this law and its related examples in various industries, in order to get familiar with other economic theories.
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