This idea can be understood outside of economics theory, for example, population. The population size on Earth is growing rapidly, but this will not continue forever (exponentially). Suppose Acme’s present plant, including the building and equipment, is the equivalent of 20 units of capital.

Average total cost then declines, as the fixed costs are spread over an increasing quantity of output. In the average cost calculation, the rise in the numerator of total costs is relatively small compared to the rise in the denominator of quantity produced. However, as output expands still further, the average cost begins to rise. At the right side of the average cost curve, total costs begin rising more rapidly as diminishing returns come into effect.

How Many Kinds of Return to Scale Exist?

This theory argues that population grows geometrically while food production increases arithmetically, resulting in a population outgrowing its food supply. Malthus’ ideas about limited food production stem from diminishing returns. The law of diminishing returns is related to the concept of diminishing marginal utility. Diminishing marginal productivity can also involve a benefit threshold being exceeded. For example, consider a farmer using fertilizer as an input in the process for growing corn. Each unit of added fertilizer will only increase production return marginally up to a threshold.

1. The law of diminishing marginal returns shows that additional factors of production result in smaller increases in output at a point.
2. This was the origin of the Malthusian theory of population, which stated that the global population would one day outgrow its food supply.
3. If the factory increases the number of workers, more shoes will be produced, because there will be more workers making the shoe parts and the stitching machine will be utilized more efficiently.
4. The last column, marginal shirts, refers to how many shirts the most recently hired worker produced.

In economics, a production function relates physical output of a production process to physical inputs or factors of production. It is a mathematical function that relates the maximum amount of output that can be obtained from a given number of inputs – generally capital and labor. The production function, therefore, describes a boundary or frontier representing the limit of output obtainable from each feasible combination of inputs.

How Would the Law of Diminishing Returns be Tested?

There are two types of laws that work in the three stages of production. One is law of increasing returns in stage I and law of diminishing returns in stage II. There are several factors that are responsible for the application of these laws. Among these factors, one of the most important factors for the law of increasing returns is fixed capital.

Example Three: Factory

Classical economists such as Malthus and Ricardo attributed the successive diminishment of output to the decreasing quality of the inputs whereas Neoclassical economists assume that each “unit” of labor is identical. Diminishing returns are due to the disruption of the entire production process as additional units of labor are added to a fixed amount of capital. The law of diminishing returns remains an important consideration in areas of production such as farming and agriculture. If Acme produces 0 jackets, it will use no labor—its variable cost thus equals $0 (Point A′).

The price of labor is the prevailing diminishing marginal returns implies wage rate, since wages are the cost of hiring an additional unit of capital. The law of diminishing marginal returns is made possible by the fact that certain factors of production are fixed. The four factors of production – capital, labor, land and entrepreneurship – cannot all be increased in every instance. Before we turn to the analysis of market structure in other chapters, we will analyze the firm’s cost structure from a long-run perspective. Whatever the firm’s quantity of production, total revenue must exceed total costs if it is to earn a profit. As explored in the chapter Choice in a World of Scarcity, fixed costs are often sunk costs that a firm cannot recoup.