Economics

Diminishing Returns

Published Dec 26, 2022

Definition of Diminishing Returns

The concept of diminishing returns states that as more of a factor of production is added to a production process, its marginal output will eventually decrease. That means the additional output from each additional input unit will eventually become smaller.

Example

To illustrate this, let’s look at a farmer who owns a small plot of land. He decides to plant corn on it and hires a few workers to help him. At first, the additional workers help him to increase the output of corn significantly. However, after a certain point, hiring additional workers won’t help him to increase the output any further. That’s because the land can only produce a certain amount of corn, and the additional workers can’t do anything to increase that. As a result, the farmer experiences diminishing returns.

Why Diminishing Returns Matters

Diminishing returns are an important concept for understanding the behavior of firms in a competitive market. It explains why firms in a competitive market can’t increase their profits indefinitely. That’s because the additional output from each additional input unit eventually becomes smaller. Thus, the firm can only increase its profits up to a certain point. Beyond that, the additional output from each additional unit of input is too small to make a significant difference.

Disclaimer: This definition was written by Quickbot, our artificial intelligence model trained to answer basic questions about economics. While the bot provides adequate and factually correct explanations in most cases, additional fact-checking is required. Use at your own risk.