FARM ECONOMICS

THE LAW OF DIMINISHING RETURNS

WHAT IS THE LAW OF

DIMINISHING
RETURNS?
Look at this video about
marginal returns.

DEFINITION of MARGINAL RETURNS

Marginal return- refers to the
additional output resulting from a one
unit increase in the use of variable
inputs, while other inputs are held
constant

Law of Diminishing Returns

Thelaw of diminishing returns, also
referred to as the law of diminishing
marginal returns, states that in a
production process, as one variable input
is increased, holding all other factors
constant, there will be a point at which the
marginal per unit output will start to
decrease.

A Farmer Example of Diminishing

Returns
Consider a corn farmer with one acre of land. In addition to
land, other factors include quantity of seeds, fertilizer,
water, and labor. Assume the farmer has already decided
how much seed, water, and labor he will be using this
season. He is still deciding on how much fertilizer to use. As
he increases the amount of fertilizer, the output of corn will
increase.
The law of diminishing returns states that there will be a
point where the additional output of corn gained from one
additional unit of fertilizer will be smaller than the additional
output of corn from the previous increase in fertilizer. This
table shows the output of corn per unit of fertilizer.

TABLE
DEMONSTRATING
DIMINISHING
RETURNS
With each additional unit of
fertiliser added, marginal output
increased until a point (4 units of
fertilizer) where it actually
decreases. If the farmer
continues to increase the fertiliser
used, marginal returns become
negative

Farmer Output
As the farmer increases from one to two units of
fertilizer, total output increases from 100 to 250
ears of corn. Therefore the marginal, or additional,
ears of corn gained from one more unit of fertilizer
is 150 (250 - 100). From two to three units of
fertilizer, the total output increases from 250 to 425
ears of corn, a 175 marginal increase.
Note that at the sixth unit of fertilizer, the farmer
starts to experience negative returns, where the
increase in fertilizer actually decreases the total
output and the marginal output becomes negative.

GRAPH DEMONSTRATING

NOW LOOK AT THIS VIDEO AND AN

SWER THE QUESTIONS ASKED
CLICK ON THE WORDS IN BLACK

THE PRODUCTION FUNCTION

Economists recognize three distinct stages of
production, which are defined by the concept
of the law of diminishing marginal returns.
The idea of the three stages of production
helps companies set production schedules and
make staffing decisions.
Consider the table in the next slide

Fixed Input
Land
(1ha)

Variable
Input
Fertiliser
(100kg/unit
)

Total
output of
Corn (100
kg/unit)

Marginal
output of
Corn (100
kg/ unit)

Average
output of
Corn (100
kg/unit)

3.0

3.5

13

4.3

20

5.0

25

5.0

28

4.7

30

4.3

31

3.9

31

3.4

10

30

-1

3.0

11

27

-3

2.5

12

22

-5

1.8

Can you tell

how the
average
output is
calculated?

The three curves are

plotted from the table
in the previous slide.
The three curves
represent the total
product, the average
product and the
marginal product.

Stage One

Stage one is the period of most growth in a farms production. In this period, each
additional variable input will produce more products. This signifies an increasing
marginal return. As an example, if one employee harvests 5 baskets by himself, two
employees may produce 15 baskets between the two of them. All three curves are
increasing and positive in this stage.

Stage Two

Stage two is the period where marginal returns start to decrease. Each additional
variable input will still produce additional units but at a decreasing rate. This is
because of the law of diminishing returns: Output steadily decreases on each additional
unit of variable input, holding all other inputs fixed. For example, if a previous
employee added 9 more baskets to production, the next employee may only add 8
more baskets to production. The total product curve is still rising in this stage, while
the average and marginal curves both start to drop

Stage Three

In stage three, marginal returns start to become negative. Adding more variable inputs
becomes counterproductive; an additional source of labor will lessen overall
production. For example, hiring an additional employee to harvest will actually result in
fewer baskets produced overall. This may be due to factors such as labor capacity and
efficiency limitations. In this stage, the total product curve starts to trend down, the
average product curve continues its descent and the marginal curve becomes negative

REVIEW QUESTION