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Law of Diminishing Returns The Law of diminishing returns is a key one in
economics. It is used to explain many of the ways the economy works and changes.
It is a relatively simple idea; spending and investing more and more in a
product where one of the factors of production remains the same means the
enterprise will eventually run out of steam. The returns will begin to diminish
in the long run. If more fertilizer and better machinery are used on an acre of
farmland, the yield will increase for a while but then begin to slow and become
flat. A farmer can only get so much out of the land, and the more the farmer
works, the harder it gets.
The economic reason for diminishing returns of
capital is as follows: When the capital stock is low, there are many workers for
each machine, and the benefits of increasing capital further are great; but when
the capital stock is high, workers already have plenty of capital to work with,
and little benefit is to be gained from expanding capital further. For example,
in a secretarial pool in which there are many more secretaries than computer
terminals, each terminal is constantly being utilized and secretaries must waste
time waiting for a free terminal.
In this situation, the benefit in terms of
increased output of adding extra terminals is high. However, if there are
already as many terminals as secretaries, so that terminals are often idle and
there is no waiting for a terminal to become available, little additional output
can be obtained by adding yet another terminal. Another application for this law
is in Athletics, for runners, their investment is the time and energy put into
training and the yield is hopefully improved fitness. Early in their running
careers or early in the training program a couple of weeks of regular training
would be rewarded with a considerable increase in fitness. Having achieved a
very fit state though, two weeks of regular training will achieve a barely
perceptible increase in fitness. But in today’s world, this famous law seems to
have been turned on its head. In Japan, for example, huge amounts of investment
have resulted in large increases in the economy and large increases in capital
goods per worker. But the rate of productivity growth did not decline the way
one would have expected on the basis of diminishing returns. Japan got ahead and
stayed ahead.
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