Law of Diminishing Marginal Returns – Definition, Causes, and Examples
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The Law of Diminishing Marginal Returns holds significant importance in economics, serving as a key tool for comprehending the productivity patterns of different factors of production.
Its fundamental objective is to assess how effectively organizations distribute their resources to achieve the highest possible output and profitability. This article aims to explain its significance comprehensively and offer illustrative examples to enhance comprehension.
Definition of Law of Diminishing Marginal Returns
The Law of Diminishing Marginal Returns is an economic concept that asserts when extra units of a variable input, like labour or capital, are introduced to a fixed input, the subsequent rise in output will eventually dwindle, leading to reduced returns.
This occurrence transpires because, beyond a certain threshold, the effectiveness of each supplementary input begins to diminish. This concept holds substantial significance in economics, aiding businesses and economists in determining when to limit resource allocation to prevent wastage and inefficiency.
Causes of Diminishing Marginal Returns
Beyond a specific production stage, businesses experience a decline in productivity, marking a pivotal concept in economics where efficiency begins to wane. At this juncture, businesses might contemplate discontinuing production or reevaluating their pricing strategies due to the rising marginal costs.
Numerous factors contribute to the phenomenon of diminishing marginal returns. Illustrative instances encompass:
1. Fixed Costs
Diminishing Returns can manifest when a business must invest in new capital equipment or other fixed expenses. For instance, a manufacturer might establish a new factory, but its output could be lower than existing facilities, leading to diminishing returns.
2. Lower levels of Productivity
Beyond a certain threshold, adding more employees can become counterproductive. For instance, having two staff in a coffee house might suffice, but hiring a third, fourth, or fifth worker could lead to an inefficient and disorderly environment. These additional employees might also converse with each other instead of attending to their assigned tasks.
3. Limited Demand
A company might decide to employ an extra worker to meet increased demand, but it might not utilize the full capacity of that employee. For instance, an employee may be able to produce 10 units, but the market demand is only for 5 units. Consequently, the employee produces only 5 units, leading to diminishing returns. This scenario is often observed in local stores with limited customer traffic.
4. Short Run
Diminishing Marginal Returns is confined to the short term, as all factors become variable in the long run. For instance, adding an extra employee to the café might initially lead to chaos, but over time, the staff could adapt to collaborate more efficiently, ultimately yielding improved returns.
Diminishing Marginal Returns Examples
The following are examples of diminishing marginal returns
Farms provide a traditional illustration of Diminishing Marginal Returns, given their finite acreage for cultivation. Consider a scenario with 100 acres, and where each worker can manage 25 acres. In this case, only four employees are required, and employing more would result in diminishing returns.
A similar principle applies to fertilizer application, where an optimal amount can enhance crop growth. Excessive use of fertilizer can harm the crops, while the right amount can lead to increased output.
Students typically allocate around 5 to 6 hours to classroom learning in education. Some may dedicate an additional 2 hours each night for revision. However, there comes a juncture where continued revision doesn’t lead to better comprehension. For instance, if student X engages in 12 consecutive hours of revision, the effectiveness of those final hours is likely to be limited.
We all experience a point where our interest or engagement in a subject diminishes. Beyond this threshold, our motivation becomes the primary driving force. This may not be the most efficient way to learn and can result in diminishing returns regarding the amount of information retained.
3. Coffee House
The Coffee House scenario illustrates how excessive employees can lead to confusion and operational inefficiencies. For instance, if three baristas already work in the coffee shop, they can effectively serve customers. However, when an additional employee is introduced, communication problems may arise, and they might obstruct each other’s tasks. There could even be instances where two baristas unintentionally prepare the same order.
To illustrate this to an extreme, envision a scenario where 100 workers are crammed into your local coffee shop. As one can imagine, the situation would become highly chaotic. At a certain point, adding yet another employee would begin to decrease the overall operational efficiency.
4. Social media marketing
An apt illustration of diminishing returns can be found in social media marketing. While it might be tempting to assume that doubling the budget for a social media marketing campaign will result in a twofold increase in returns, this escalation could inundate a social media platform with excessive information, ultimately causing a reduction in returns.
To tackle this issue, a marketing department should assess and modify other factors, such as the choice of channels and the approach to social media monitoring and analytics.
I’m certain you found the subject intriguing. Every company aims to minimize losses and avoid wastage in their production processes. Similarly, in the context of education, students have a finite window for effective learning. When you extend the teaching period, you’ll notice that much of the material discussed earlier can be forgotten.
In the case of businesses with a large workforce, some employees may become less motivated to exert effort because of the sheer number of colleagues. This phenomenon suggests that while excessive fertilizer application in farming can lead to damage, using a more moderate amount can still yield positive results.