law of diminishing returns

Examples of law of diminishing returns in the following topics:

• The Law of Diminishing Returns

  • The law of diminishing returns states that adding more of one factor of production will at some point yield lower per-unit returns.
  • In economics, diminishing returns (also called diminishing marginal returns) is the decrease in the marginal output of a production process as the amount of a single factor of production is increased, while the amounts of all other factors of production stay constant.
  • The law of diminishing returns states that in all productive processes, adding more of one factor of production, while holding all others constant ("ceteris paribus"), will at some point yield lower per-unit returns .
  • The law of diminishing returns does not imply that adding more of a factor will decrease the total production, a condition known as negative returns, though in fact this is common.
  • However, as marginal costs increase due to the law of diminishing returns, the marginal cost of production will eventually be higher than the average total cost and the average cost will begin to increase.

• Marginal Product of Labor (Physical)

  • gives another example of marginal product of labor.
  • The law of diminishing marginal returns ensures that in most industries, the MPL will eventually be decreasing.
  • The law states that "as units of one input are added (with all other inputs held constant) a point will be reached where the resulting additions to output will begin to decrease; that is marginal product will decline. " The law of diminishing marginal returns applies regardless of whether the production function exhibits increasing, decreasing or constant returns to scale.
  • Under such circumstances diminishing marginal returns are inevitable at some level of production.
  • This table shows hypothetical returns and marginal product of labor.

• Total Factor Productivity

  • Total factor productivity measures the residual growth in total output of a firm, industry, or national economy that cannot be explained by the accumulation of traditional inputs such as labor and capital .
  • However, due to to the law of diminishing returns, the increased use of inputs will fail to yield increased output in the long run.
  • The quantity of inputs used thus does not completely determine the amount of output produced.
  • How effectively the factors of production are used is also important.
  • Total output is not only a function of labor and capital, but also of total factor productivity, a measure of efficiency.

• Optimal Quantity of a Public Good

  • The government is providing an efficient quantity of a public good when its marginal benefit equals its marginal cost.
  • To determine the optimal quantity of a public good, it is necessary to first determine the demand for it.
  • Due to the law of diminishing marginal utility, the demand curve is downward sloping.
  • Because of the law of diminishing returns, the marginal cost increases as the quantity of the good produced increases.
  • The optimal quantity of public good occurs where MB = MC.

• Inputs and Outputs of the Function

  • A production function relates the input of factors of production to the output of goods.
  • The price of labor is the prevailing wage rate, since wages are the cost of hiring an additional unit of capital.
  • The marginal product of an input is the amount of output that is gained by using one additional unit of that input.
  • For example, if the production function is Q=3K+2L (where K represents units of capital and L represents units of labor), then the marginal product of capital is simply three; every additional unit of capital will produce an additional three units of output.
  • Inputs are typically subject to the law of diminishing returns: as the amount of one factor of production increases, after a certain point the marginal product of that factor declines.

• Economies and Diseconomies of Scale

  • Increasing, constant, and diminishing returns to scale describe how quickly output rises as inputs increase.
  • There are three stages in the returns to scale: increasing returns to scale (IRS), constant returns to scale (CRS), and diminishing returns to scale (DRS).
  • Returns to scale vary between industries, but typically a firm will have increasing returns to scale at low levels of production, decreasing returns to scale at high levels of production, and constant returns to scale at some point in the middle .
  • The final stage, diminishing returns to scale (DRS) refers to production for which the average costs of output increase as the level of production increases.
  • Identify the three types of returns to scale and describe how they occur

• Defining the Production Function

  • This is also known as diminishing returns to scale - increasing the quantity of inputs creates a less-than-proportional increase in the quantity of output.
  • If it weren't for diminishing returns to scale, supply could expand without limits without increasing the price of a good.
  • If a firm has a production function Q=F(K,L) (that is, the quantity of output (Q) is some function of capital (K) and labor (L)), then if 2Qdiminishing returns to scale.
  • Similarly, if 2Q>F(2K,2L), there are increasing returns to scale, and if 2Q=F(2K,2L), there are constant returns to scale.
  • From this production function we can see that this industry has constant returns to scale - that is, the amount of output will increase proportionally to any increase in the amount of inputs.

• Implications and Limitations of the Efficient Market Hypothesis

  • According to a publication by Dreman and Berry from 1995, low P/E stocks have greater returns.
  • Additionally the concept of liquidity is a critical component to capturing "inefficiencies" in tests for abnormal returns.
  • Any test of this proposition faces the joint hypothesis problem, where it is impossible to ever test for market efficiency, since to do so requires the use of a measuring stick against which abnormal returns are compared-- in other words, one cannot know if the market is efficient if one does not know if a model correctly stipulates the required rate of return.
  • The financial crisis has led Richard Posner, a prominent judge, University of Chicago law professor, and innovator in the field of Law and Economics, to back away from the hypothesis and express some degree of belief in Keynesian economics.
  • The strong form of EMH is diminished by the 2008 crisis

• Social Impacts of Monopoly

  • A monopoly can diminish consumer choice, reduce incentives to innovate, and control supply to enforce inequitable prices in a society.
  • However, perfect competition is more of a theoretical competitive framework because markets will naturally deviate to varying degrees (in order to capture profitable returns).
  • In order to ensure that suppliers do not take on too much power (such as the case of monopolies and oligopolies), government regulations and antitrust laws are a necessary component of the economic perspective.
  • In summarizing these various societal drawbacks, monopolies pose the risk of reducing consumer choice and consumer power to incentivize companies to innovate and reduce costs, as there is limited prospective returns on investment.
  • Note that the overall returns derived, costs incurred, quantity produced, and price point all align perfectly to generate an equitable market position.

• The Agrarian and Populist Movements

  • The Grange, or Order of the Patrons of Husbandry, was a secret order founded in 1867 to advance the social and economic needs of farmers.
  • Such laws were known as Granger Laws, and their general principles, endorsed in 1876 by the Supreme Court of the United States, remain important to the current American legal system.
  • In a declaration of principles in 1874, the Grangers declared that they were not enemies of the railroads, and that they were not advocates of communism or agrarianism.
  • By 1876, the organization was diminishing in national importance.
  • For the Southern farmer, a clear enemy was the crop-lien system, in which farmers mortgaged their future crops in return for furnished supplies.