Law of Diminishing Returns

The law of diminishing marginal returns

What you need to know...

The law of diminishing returns is an economic concept which exists to explain the parabola shape of the short-run average cost curve.

The first most important thing to remember is that in the short-term at least one factor of production (land, labour, capital and enterprise) is fixed, for example, the time period a firm only has three printers/computers/machines.

The average cost curve can be split into three parts: the downward sloping part, the middle part and the upward sloping curve. 

The downward sloping curve

The downward sloping part shows that as a firm increases labour the productivity increase. The marginal product (additional product per worker) increases too. This section seems logical.

The middle part

The middle part is where the total productivity is increasing but the marginal product is decreasing. This is because the resources are fixed. For example, if I own a gardening company which has two lawnmowers, when I recruit my third person the amount of productivity they can add to the business will be less than the first and second person as there are only two lawnmowers. 

The upward sloping curve

This is when total productivity starts to fall and the marginal product is negative. This is because what happens is the workers start getting in each others way and the motivation disappears. This makes sense because if there are too many people then no-one will work (just think of large study/revision get togethers).