Concept of Diminishing Returns
The concept of diminishing returns comes from economics, where it's one of the basics of production theory, the study of turning economic "inputs," such as money or manpower, into "outputs," or goods and services. Simply put, diminishing returns occurs when successively greater input produces lesser and lesser output.
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Returns
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A frequently cited example of the concept of diminishing returns concerns a farmer hoping to boost production--of, say, corn--on a plot of land. One year, he plants corn but doesn't apply any fertilizer, and come harvest time, he has a yield of 100 bushels per acre. The next year, he puts down one ton of fertilizer, and he gets a yield of 115 bushels per acre. The year after that, he puts down two tons of fertilizer, and his field returns 130 bushels of corn per acre. At this point, he's getting a steady return: Each ton of fertilizer ups his harvest by 15 bushels per acre.
Marginal Returns
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In the fourth year, the farmer lays down three tons of fertilizer, and ends the year with a harvest of 140 bushels per acre. In year 5, he puts down four tons and has a harvest of 145 bushels per acre. He's experiencing what's called "diminishing marginal returns." That is, the return he gets for each additional input--each extra ton of fertilizer--is getting smaller and smaller. Depending on the cost of fertilizer and the price he gets for his corn, those third and fourth tons of fertilizer may actually be costing him money.
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Total Returns
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Year 6 comes around, and the farmer goes ahead and puts down five tons of fertilizer. But at this point the soil has been overworked, and there's so much fertilizer in the ground that it's starting to harm the plants. When the harvest comes in, his yield has dropped to 130 bushels per acre. That extra ton of fertilizer has led to a net loss in output. He's now experiencing "diminishing total returns."
Fixed Factors
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A key consideration is that other factors of production must be fixed, or unchanging, to create an environment in which diminishing returns can occur. In the case of the farmer, it's the size of his field and the amount of seed he plants. If every year he planted more seed on more ground, then the steady increase in fertilizer might not have produced the diminishing returns.
Diseconomies of Scale
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Diminishing returns is not to be confused with "diseconomies of scale," a different kind of production inefficiency. In diseconomies of scale, each additional input can produce the same output, but at a greater cost. For example, a factory might keep adding workers to boost production, but eventually it can't find any more workers at the rate it's paying, so it needs to raise wages. At the same time, the increased production saturates the local market, so the products must be shipped longer distances to new markets.
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References
- Photo Credit Corn image by DSL from Fotolia.com
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