LAW OF DIMINISHING

RETURNS
SUBMITTED BY:-
VAIBHAV RAI
1402202
AS THE PROPORTION OF ONE FACTOR IN A
COMBINATION OF FACTORS IS INCREASED,
AFTER A POINT, FIRST THE MARGINAL AND
THEN THE AVERAGE PRODUCT OF THAT
FACTOR WILL DIMINISH.
Assumption Of The Law:-
Only one factor is varied and all other factors remain fixed

The fixed factor and the variable factor are combined together in
variable proportions in the process of production.

The law operates in the short run.

Ex: Consider the production of Waldos TexMex Tacos.
The table presents the hourly production of Tacos as
Waldo's TexMex Taco World employs different quantities
of labour, the key variable input for short-run taco
production.
Fixed : taco-producing kitchen - equipment and utensils

The first column is the number of workers, the second is
the total hourly production of Tacos and the third column
is the marginal product generated by each additional
worker
In our example in table 1, there are increasing returns to labour for the first three
units of labour employed. The law of diminishing returns sets in with addition of the
fourth worker. Both the average and the marginal products increase at first and then
decline. The marginal product declines faster than the average product. When 9
men are employed, total product is at a maximum. The marginal product of the
10
th
labourer is negative
Units of Input (L) Total Product (TP)
Marginal Product
(MP)
Average Product (AP) Stage
1 100 100 100 I
2 220 120 110 I
3 360 140 120 I
4 460 100 115 II
5 530 70 106 II
6 570 40 95 II
7 595 25 85 II
8 600 5 75 II
9 600 0 67 II
10 594 -6 66 III
11 560 -34 56 III
Total Product Marginal Product Average Product
Stage I (Increases) Increases Increases
Stage I (increases)
Reaches a maximum and
begins to diminish
Continues to increase
Stage II (Continues to
increase at a diminishing
rate)
Continues to diminish
Reaches maximum and
begins to diminish
Stage II (Reaches
maximum)
Becomes zero Continues to diminish
Stage III (Diminishes) Becomes negative
Continues to diminish but
must always be greater
than zero
Units of Input (L) Total Product (TP)
Marginal Product
(MP)
Average Product
(AP)
Stage
1 100 100 100 I
2 220 120 110 I
3 360 140 120 I
4 460 100 115 II
5 530 70 106 II
6 570 40 95 II
7 595 25 85 II
8 600 5 75 II
9 600 0 67 II
10 594 -6 66 III
11 560 -34 56 III
No profit maximizing production would take place in stage I or III

In stage I, the proportion of variable factor to fixed factor is low. Therefore, by adding one
more unit of labour, the producer can increase the average productivity for all the units.

A restaurant with 100 tables and only 2 waiter would be operating in a stage I of the short-run
production
function. By increasing the amount of labour in stage I and the average product of labour increases.

As for stage III, it does not pay the producer to be in this region because by reducing the
labour input he can increase total output and save in the cost of a unit of labour. In this
stage, there is too much of the variable factor relation to the fixed factor.

A restaurant with too many waiters in relation to the number of tables is an example of stage III.
Therefore, stage III is considered as an irrational phase of production. Nevertheless, it is quite likely that a
firm lacking perfect knowledge may be operating in this stage. In agriculture, this may be found to be very
common.

Stage II is the only stage in which there is neither a redundancy of the variable factor nor a
redundancy of the fixed factor. Throughout this range the average product of labor
declines, but he marginal product is positive. Thus, the economically meaningful range is
the II stage.