Imagine this situation. You hire a teenager to tend to your garden. He plants 4 saplings in an area of 10 square feet in 4 hours. The next day, he brings another friend along and you decide to hire him as well. The time given and the area given does not increase, but the number of saplings planted increases to 8. Another boy comes along and is hired. Again the area and the time limit is the same. But the number of boys is now 3. And the number of total saplings planted is now 9. If you hire another boy and maintain the same condition, you will notice that the number of saplings planted may increase overall, but the number of saplings planted by each boy will reduce, until eventually it will be 0. The above explained situation is a classic example of the law of diminishing returns. What is that? Let's find out in this article.
As per the 17th edition of Samuelson & Nordhaus, Microeconomics, the definition of the law of diminishing returns states that "We will get less and less extra output when we add additional doses of an input while holding other inputs fixed. In other words, the marginal product of each unit of input will decline as the amount of that input increases holding all other inputs constant."
Now let us see what this means in simple language. This law simply states that ceteris paribus (all conditions remaining constant), if one condition in a particular production process is continuously increased, then after a certain point of time, the returns obtained from that production will reduce on a per unit level. This means that though the overall output of the production process may increase, the level of increase, i.e., the difference between the pre-change and the post-change, will be lesser than the original production level.
The law of diminishing returns is also called the law of diminishing marginal returns. In order to understand it further, let us see another example of this law that was propounded and used by many leading names in economics, like David Ricardo.
You have a sewing business. In this sewing business, you have 10 sewing machines and 5 employees. The fixed shift duration for all employees is 8 hours per day. On an average, in 1 day, each employee sews 5 shirts. When you hire 1 more employee, he takes care of maintenance and other chores. Soon, he gets trained in sewing too. So he begins to sew. The number of machines is still 10 and the duration of the shift is also still 8 hours per day.
What you will see is that even if the new person comes in late by 1 or 2 hours, the total number of shirts sewn may increase from 50 shirts (10 × 5) per day to around 53. This level of increase (3 shirts) is still lower than the total number of shirts produced by 1 employee (5 shirts). This may be due to many factors; the new employee may not be used to sewing, he may have to wait for a while to use a machine due to the limited number of machines, etc.
All these factors will contribute to the decreasing per employee output. There is no standard formula for the law of diminishing returns, but you can try out using your cost of production as a base and the average output multiplied by the working hours and by gradually adding one more unit of production, you will see that the production level will begin to decline.
The law of diminishing returns is closely related to the law of supply and demand, because ultimately it is a production-centric law, which in turn, is responsible for the demand and supply of goods and commodities.