key term - Law of Diminishing Returns

Definition

The law of diminishing returns states that as more of a variable input (such as labor) is added to a fixed input (such as capital), the marginal output will eventually decrease, holding all other factors constant. This principle has important implications for production and economic decision-making.

5 Must Know Facts For Your Next Test

1. The law of diminishing returns explains why the marginal product of a variable input eventually decreases as more of that input is added to a fixed input.
2. This principle is crucial for understanding the shape of the production possibilities frontier and how it changes as resources are reallocated.
3. Diminishing returns can lead to tradeoffs and opportunity costs, as allocating more resources to one good means producing less of another.
4. The law of diminishing returns is a key factor in determining the optimal combination of inputs for production and the most efficient use of resources.
5. Understanding diminishing returns is essential for making informed social choices, such as how to allocate limited resources to maximize societal welfare.

Review Questions

• Explain how the law of diminishing returns relates to the production possibilities frontier.
  • The law of diminishing returns directly influences the shape of the production possibilities frontier. As more of a variable input, such as labor, is added to a fixed input, like capital, the marginal product of that variable input will eventually decrease. This means that the opportunity cost of producing one good increases as more resources are allocated to it, causing the production possibilities frontier to become concave or bowed outward. The law of diminishing returns thus helps explain the tradeoffs and opportunity costs faced by society when making choices about how to allocate scarce resources.
• Describe how the law of diminishing returns impacts social choices and the optimal allocation of resources.
  • The law of diminishing returns is a crucial consideration when society must make choices about how to allocate its limited resources. As more of a variable input is added to a fixed input, the marginal benefit of that additional input will eventually decrease. This means that at some point, it may be more efficient to reallocate resources to the production of another good, as the opportunity cost of producing the first good becomes too high. Understanding diminishing returns allows policymakers and economic decision-makers to determine the optimal combination of inputs and the most efficient use of resources to maximize societal welfare and achieve the best possible outcomes for the community.
• Analyze how the law of diminishing returns influences the shape of the production possibilities frontier and the tradeoffs faced by society.
  • $$The law of diminishing returns is a key determinant of the shape of the production possibilities frontier (PPF). As more of a variable input is added to a fixed input, the marginal product of that variable input will eventually decrease. This causes the PPF to become concave or bowed outward, reflecting the increasing opportunity cost of producing additional units of a good. The law of diminishing returns thus highlights the tradeoffs and opportunity costs faced by society when making decisions about how to allocate its scarce resources. Policymakers must carefully consider the implications of diminishing returns to ensure the most efficient and socially optimal use of resources.\$$

Related terms

Marginal Product: The additional output produced by adding one more unit of a variable input, such as labor, while holding all other inputs constant.

Production Function: The mathematical relationship between the quantity of inputs used in production and the maximum possible output.

Opportunity Cost:

The cost of an alternative that must be forgone in order to pursue a certain action or choice.