|Diminishing returns, law of|
The hypothesis that if one factor of production is increased by small constant amounts, all other factor quantities being held constant, then after some point the resulting increases in output become smaller and smaller. Before this point is reached output may increase by constant or by increasing amounts. It is assumed under this law that the units of the variable factor are identical. Since it assumes at !east one fixed factor, the hypothesis relates to the short-run. Although it is called a 'law', it is simply an assertion that economists make about the nature of technology in the real world, and would be refuted if it was found that under the conditions it assumes (homogeneous inputs, fixed technology) returns did not in fact tend to diminish. However, logically it appears quite plausible. Keeping fixed the numbers of machines and steadily increasing the number of workers must mean that, at some point, adding another worker adds less to output than did the addition of the previous worker; finally, the variable factor may become so numerous relative to the fixed factor that further additions of the former add nothing to output, or even cause a decrease in output ('too many cooks spoil the broth'). The 'law' or hypothesis is important because it underlies the theory of short-run cost curves and hence the short-run theories of the firm.
|Reference: The Penguin Dictionary of Economics, 3rd edt.|