Law of Diminishing Returns

Law of Diminishing ReturnsSubmitted By:-As the proportion of one factor in a combination of factors is increased, after a point, first the marginal and then the average product of that factor will diminish.Assumption Of The Law:- Only one factor is varied and all other factors remain fixed

The fixed factor and the variable factor are combined together in variable proportions in the process of production.

The law operates in the short run.

Ex: Consider the production of Waldos TexMex Tacos. The table presents the hourly production of Tacos as Waldo's TexMex Taco World employs different quantities oflabour, the key variable input for short-run taco production. Fixed : taco-producing kitchen - equipment and utensils

The first column is the number of workers, the second is the total hourly production of Tacos and the third column is themarginal productgenerated by each additional workerIn our example in table 1, there are increasing returns to labour for the first three units of labour employed. The law of diminishing returns sets in with addition of the fourth worker. Both the average and the marginal products increase at first and then decline. The marginal product declines faster than the average product. When 9 men are employed, total product is at a maximum. The marginal product of the 10thlabourer is negativeUnits of Input (L)Total Product (TP)Marginal Product (MP)Average Product (AP)Stage1100100100I2220120110I3360140120I4460100115II553070106II65704095II75952585II8600575II9600067II10594-666III11560-3456IIITotal ProductMarginal ProductAverage ProductStage I (Increases)IncreasesIncreasesStage I (increases)Reaches a maximum and begins to diminishContinues to increaseStage II (Continues to increase at a diminishing rate)Continues to diminishReaches maximum and begins to diminishStage II (Reaches maximum)Becomes zeroContinues to diminishStage III (Diminishes)Becomes negativeContinues to diminish but must always be greater than zeroUnits of Input (L)Total Product (TP)Marginal Product (MP)Average Product (AP)Stage1100100100I2220120110I3360140120I4460100115II553070106II65704095II75952585II8600575II9600067II10594-666III11560-3456III

No profit maximizing production would take place in stage I or III

In stage I, the proportion of variable factor to fixed factor is low. Therefore, by adding one more unit of labour, the producer can increase the average productivity for all the units.

A restaurant with 100 tables and only 2 waiter would be operating in a stage I of the short-run production function. By increasing the amount of labour in stage I and the average product of labour increases.

As for stage III, it does not pay the producer to be in this region because by reducing the labour input he can increase total output and save in the cost of a unit of labour. In this stage, there is too much of the variable factor relation to the fixed factor.

A restaurant with too many waiters in relation to the number of tables is an example of stage III. Therefore, stage III is considered as an irrational phase of production. Nevertheless, it is quite likely that a firm lacking perfect knowledge may be operating in this stage. In agriculture, this may be found to be very common.

Stage II is the only stage in which there is neither a redundancy of the variable factor nor a redundancy of the fixed factor. Throughout this range the average product of labor declines, but he marginal product is positive. Thus, the economically meaningful range is the II stage.