Principle of Diminishing Returns
The Law of Diminishing Returns helps businesses operate with an acceptable profit margin. It determines how many workers are needed to efficiently allocate resources and capital.
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History
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The Law of Diminishing Returns was outlined by British economist Thomas Malthus in his work "An Essay on the Principle of Population," published in 1798. Malthus worried that population growth would outstrip the ability to produce food, leading to starvation.
Theory
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A worker's production is limited because resources, including land and materials, are limited. Adding workers can slightly increase the amount produced but will eventually decrease the amount each individual worker makes. The point of diminishing returns is reached when individual productivity drops.
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Effects
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The Law of Diminishing Returns only applies to the short run, because increasing productivity through better technology or business models is achievable over time.
Considerations
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Most companies operate under a point of diminishing returns to meet demands, unless prohibited by cost. Reducing the workforce to create greater individual productivity will not meet consumer demands, driving prices up. This decreases demand, which the company does not want.
Famous Example
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The most famous example of the Law of Diminishing Returns follows Malthus's agrarian model. Fertilizer is added to a piece of land. At some point, adding more fertilizer is wasteful because it will not increase plant production.
Expert Insight
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Malthus's prediction that an increase in population would lead to starvation has not yet come to fruition, but it continues to receive attention. Experts at the Monsanto Company believe that nine billion people, three billion more than exist in 2009, could cause food shortages.
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