The law of diminishing returns is also referred to as the law of diminishing marginal returns. It implies that an increase in one input does not necessarily increase the amount of returns proportionally, in case when all other factors are held constant (Rasmussen, 2010). It applies to cases where a firm has both variable and fixed inputs. Planting of seeds on a farm can be a vivid illustration. For instance, the return from a kilogram of maize seeds planted on one acre plot is 2 tons. If we double the amount of seed that we use for planting to two kilos, and leave all the other factors constant, the return from the farm will not be 4 tons for the one acre plot. It will be less. Though the amount of seed was increased, the plot size remained the same and other inputs, such as fertilizers and labor, remained constant. If another kilo of seed will be added, the output increase will also be less than the increase gained from the second kilo. This reduction of output will retrogressively change as more of the input is introduced. At some point, there would be no increase in returns no matter how many kilos are planted on the acre of land.
Another example is that of a small café. If the manager adds an employee, the services will significantly improve. If a second employee is added, his efficiency will be less than the one received from the first addition. If this is continued, there would come a moment when any other addition has no effect on output. Therefore, the rate of returns reduces as more of the input is added. These two illustrations explain the law of diminishing returns.
Explain the Effects of Diminishing Returns on the Cost
Increase in input leads to increase in cost. It is, therefore, true to say that as more input is introduced, the more cost is incurred by the business. As the returns diminish with an increase in the input and consequential the increase in cost, the profitability of the product is reduced, as well (Rasmussen, 2010). Once the return gets to its maximum, it starts to decrease with every unit of input that is added. Good business managers ensure that there is a stable balance between cost and returns. The trend of cost against returns forms a curve.
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No. of workers |
0 |
1 |
2 |
3 |
4 |
5 |
6 |
7 |
8 |
9 |
10 |
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Units of output |
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8 |
14 |
18 |
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23 |
23.6 |
24 |
24 |
Figure 1: Data showing the units of output obtained of the increase in the number of employees, working on a farm.
Figure 2: The rate of returns with the increase of the number of workers, and their effects on the output (The graph demonstrates output units against the number of employees)
In this example, there is no difference in employing 9 or 10 people. Since the more employers there are the more the cost increases, the good managers look at the point where the rate of change of returns starts to diminish and maintain their cost and input. From the graph above, it is evident that 3-4 workers would be an ideal number to work on the farm to minimize cost and maximize returns.
What Is Cost?
Cost refers to the money value of the resources that have been used to produce a commodity. It is, therefore, not there to be used again. For instance, the monetary value of the flour used to bake a loaf of bread is its cost and cannot be applied for any other commodity. Increase in cost does not necessarily mean an increase in products since there are many other factors that affect production of commodities.
What Is Marginal Cost?
Marginal cost is the increase in cost that is added to the initial cost when a single unit of the product is added to the production line (Sullivan, & Sheffrin, 2003). It is correctly defined as total change in total cost divided by the total change in quantity.
If the cost of producing 50 pieces of hamburgers is $50, the average cost is a dollar per burger. If we increase the number of burgers to 60 and incur $54 in the process, then the marginal cost can be calculated as the change in cost divided by change in quantity, which in this case is 4 divided by 10, to give us 0.4 dollars per extra unit. 0.4 dollars is the marginal cost. A business with a low marginal cost for a certain good is better than that with a high marginal cost. Good managers check the trend and stabilize production at the point where marginal cost starts to increase. In some businesses, economies of scale allow the business to increase production with a very small or even insignificant difference, thus, allowing the marginal cost to remain low. If the cost to pay a watchman is $300 when the firm supplies 50 units to produce a commodity, it will not increase even when the firm produces 50 more. This allows the business to produce more at little or no cost. The same case applies to rent. The variable cost, which includes the direct raw materials used in production, changes while fixed cost remains the same.
Conclusion
In conclusion, marginal cost increases with the decrease in marginal produce (Perloff, 2004). The law of diminishing returns can be best used by managers to stabilize their input. This together with the evaluation of the trend of marginal cost would allow the firm to maximize its production while minimizing the cost. This would translate to increase in profits. It is, therefore, vital for managers to study these two parameters in the course of doing business.