Diminishing Marginal Returns

Definition

Diminishing marginal returns is an economic principle that states as additional inputs are added to a production process, the marginal (incremental) output of that process will eventually decrease. This means that each additional unit of input (such as labor or capital) will yield a smaller increase in output compared to the previous unit.

5 Must Know Facts For Your Next Test

1. Diminishing marginal returns is a fundamental concept in the theory of production and the short-run production function.
2. The law of diminishing marginal returns states that as more of a variable input is added to a fixed input, the marginal product of the variable input will eventually decrease.
3. Diminishing marginal returns occur because the fixed input in the production process becomes a constraint, limiting the ability of the variable input to increase output.
4. The point at which diminishing marginal returns sets in is known as the point of diminishing returns, and it represents the most efficient use of the variable input.
5. Diminishing marginal returns have important implications for cost minimization and profit maximization in the short run.

Review Questions

• Explain the concept of diminishing marginal returns and how it relates to the short-run production function.
  • Diminishing marginal returns is the principle that as additional units of a variable input (such as labor) are added to a fixed input (such as capital), the incremental increase in output will eventually decrease. This is because the fixed input becomes a constraint, limiting the ability of the variable input to increase output. This concept is central to the short-run production function, where at least one input is fixed, and the law of diminishing marginal returns describes how the marginal product of the variable input changes as it is increased.
• Describe the relationship between diminishing marginal returns and the point of diminishing returns in the production process.
  • The point of diminishing returns is the point at which diminishing marginal returns sets in. This is the point where the marginal product of the variable input starts to decrease, even though the total product may still be increasing. At the point of diminishing returns, the variable input is being used most efficiently, as adding more of that input will result in a smaller increase in output. Understanding the point of diminishing returns is crucial for firms to minimize costs and maximize profits in the short run.
• Analyze how diminishing marginal returns affects a firm's decision-making in the short run, particularly regarding the use of variable inputs.
  • Diminishing marginal returns has important implications for a firm's decision-making in the short run. As the firm adds more variable inputs, such as labor, to a fixed input, such as capital, the marginal product of the variable input will eventually decrease. This means that the firm will need to weigh the additional revenue generated by the last unit of the variable input against the additional cost of that input. The firm will want to operate at the point of diminishing returns, where the variable input is being used most efficiently to maximize profits. Understanding diminishing marginal returns is crucial for the firm to make optimal decisions about the use of variable inputs in the short run.

Related terms

Marginal Product:

The additional output produced by adding one more unit of an input, such as labor or capital, to the production process.

Production Function:

The relationship between the quantities of inputs used and the maximum amount of output that can be produced.

Short Run:

The period of time in which at least one factor of production is fixed, while others can be varied.