The law of diminishing returns

The law of diminishing returns states that the incremental output of a production process will decline as the input quantities are incrementally increased. The classic example of diminishing returns is the application of fertiliser to an area of land. Initial applications of fertiliser provide large gains in output from the land (milk, beef, crops etc). However, although subsequent applications continue to increase the output, each incremental output is less than the preceding increment. If fertiliser applications continue to increase, total output may even fall.

This type of production function is shown in the following chart:

The solid line shows the output from the land area for given quantities of fertiliser input. At high levels of fertiliser input, total output starts to decline.

The dotted line shows the marginal output for each extra kilogram of fertiliser applied. In economics, “marginal” refers to a change “at the margin” (the incremental change). When fertiliser was increased from 100 kgs to 200 kgs, the output increased from 200 units to 280 units. Therefore, the marginal input was 100 kgs of fertiliser, and the marginal output was 80 units (280 – 200), or 0.80 units of output per kg of fertiliser.

This marginal output declines as more fertiliser is added, such that when the fertiliser is increased from 500 to 600 kgs, no extra output is produced.

This pattern of diminishing returns to incremental inputs is common in productive processes. Note, however, this applies to a situation where the production process is being intensified (as distinct from being expanded). That is, more and more fertiliser (in the above example) is being applied to the same area of land.

We could also expand production by increasing the area of land – or in general, by increasing the scale of the enterprise. Changing the scale of an enterprise can also change the relationship of inputs to outputs (economies of scale, diseconomies of scale), but scale returns should not be confused with diminishing returns as discussed here.