The law of diminishing returns is an economic concept that shows the decrease of a product or service as more productive factors are added to the creation of a good or service.
It is a marginal decrease. That is, the increase is smaller each time, so another way to refer to this phenomenon is the law of diminishing marginal returns.
According to the law of diminishing (marginal) returns, increasing the quantity of a productive factor in the production of the good or service in question, causes the output of production to be lower as we increase this factor, provided that all other factors are kept at a constant level (ceteris paribus). Typically, in the production function, the more workers there are, the higher the production.
It is necessary to explain the basic concept of diminishing marginal returns. If we increase the quantity of a productive factor and leave the quantity of the rest of the factors fixed, there will come a time when the quantity of final product we obtain is less as we produce more and more. There may even come a time when increasing a unit of factor employed (such as labor or machinery) results in a decrease in production.
In simple terms, it seems that, despite what might be thought a priori, increasing a factor not only does not increase the production of the good or service, but may even cause a gradual decrease in the quantity produced.
It is necessary to differentiate this process from that which occurs in diseconomies of scale, the opposite of economies of scale. In the latter, decreases in production increases are the consequence of the increase of all factors in the same proportion and not of only one of them, as in the case of diminishing marginal returns.
The law of diminishing returns is generally attributed to the economist David Ricardo, although its principles were defined by the Neapolitan Antonio Serra many decades earlier.
Example of the law of diminishing returns
The existence of diminishing returns may seem logical if we think about it from the following point of view: just because there are more workers in a construction project, it does not necessarily mean that the work is done faster and more efficiently.
There may come a point in which so many people working in the same space may become a hindrance due to lack of space, and they may not perform their tasks correctly. Increasing the number of workers will cause the production level to decrease for each unit of worker employed. In this case, the marginal increase in production is negative.
The same thing happens by increasing the capital factor. For example, imagine that only one person works in an orchard. The work he has to do to produce is enormous. If he buys a tractor, he will be able to perform his tasks much better. But if he buys another tractor, it will do him no good since he cannot drive both at the same time.
Just as the first tractor caused production to increase, the second tractor did not, i.e. the marginal return was zero when the second tractor was added. Let us imagine that he is given 10 more tractors. Because he will have to use part of his orchard to park them, production will be reduced, with the marginal yield decreasing for each tractor added.