Understanding the law of diminishing returns in economics

The Law of Diminishing Returns: Developed by the influential British economist David Ricardo, this fundamental economic law demonstrates that, if the quantity of a given factor of production is increased, the marginal output of the production process will decrease, leading to lower returns.

Understanding the law of diminishing returns in economics

Production output is created in the real process, gains of production are distributed in the income distribution process and these two processes constitute the production process. The production process and its sub-processes, the real process and income distribution process occur simultaneously, and only the production process is identifiable and measurable by the traditional accounting practices.

The real process and income distribution process can be identified and measured by extra calculation, and this is why they need to be analyzed separately in order to understand the logic of production and its performance.

Real process generates the production output from input, and it can be described by means of the production function.

It refers to a series of events in production in which production inputs of different quality and quantity are combined into products of different quality and quantity. Products can be physical goods, immaterial services and most often combinations of both.

The characteristics created into the product by the producer imply surplus value to the consumer, and on the basis of the market price this value is shared by the consumer and the producer in the marketplace.

This is the mechanism through which surplus value originates to the consumer and the producer likewise.

Surplus values to customers cannot be measured from any production data. Instead the surplus value to a producer can be measured. It can be expressed both in terms of nominal and real values.

The real surplus value to the producer is an outcome of the real process, real income, and measured proportionally it means productivity.

Understanding the law of diminishing returns in economics

Since then it has been a cornerstone in the Finnish management accounting theory. The magnitude of the change in income distribution is directly proportionate to the change in prices of the output and inputs and to their quantities. Productivity gains are distributed, for example, to customers as lower product sales prices or to staff as higher income pay.

The production process consists of the real process and the income distribution process. A result and a criterion of success of the owner is profitability. The profitability of production is the share of the real process result the owner has been able to keep to himself in the income distribution process.

Factors describing the production process are the components of profitabilityi. They differ from the factors of the real process in that the components of profitability are given at nominal prices whereas in the real process the factors are at periodically fixed prices. Monetary process refers to events related to financing the business.

Market value process refers to a series of events in which investors determine the market value of the company in the investment markets. Production growth and performance[ edit ] Main article: Economic growth Economic growth is often defined as a production increase of an output of a production process.

It is usually expressed as a growth percentage depicting growth of the real production output. The real output is the real value of products produced in a production process and when we subtract the real input from the real output we get the real income.

The real output and the real income are generated by the real process of production from the real inputs. The real process can be described by means of the production function. The production function is a graphical or mathematical expression showing the relationship between the inputs used in production and the output achieved.

Both graphical and mathematical expressions are presented and demonstrated. The production function is a simple description of the mechanism of income generation in production process.

Understanding the Pareto Principle (The 80/20 Rule) – BetterExplained

It consists of two components. These components are a change in production input and a change in productivity. The Value T2 value at time 2 represents the growth in output from Value T1 value at time 1.

Each time of measurement has its own graph of the production function for that time the straight lines. The output measured at time 2 is greater than the output measured at time one for both of the components of growth: The portion of growth caused by the increase in inputs is shown on line 1 and does not change the relation between inputs and outputs.

The portion of growth caused by an increase in productivity is shown on line 2 with a steeper slope. So increased productivity represents greater output per unit of input.

The growth of production output does not reveal anything about the performance of the production process. Because the income from production is generated in the real process, we call it the real income.

What is 'Law of Diminishing Marginal Returns'

The real income generation follows the logic of the production function.Diminishing Returns vs Diseconomies of Scale. Diseconomies of scale and diminishing returns are both concepts in economics that are closely related to one another.

The Law of Diminishing Marginal Returns. One such law in economics, for example, is the law of demand. It states that as the price of a good increases, the quantity demanded decreases and as the price of the good decreases, the quantity demanded increases.

By understanding how individuals react when faced with a particular set of. Importance of the Law of Diminishing Returns. We have already quoted Cairnes when he says that in the absence of the law of diminishing returns, “The science of political economy would be as completely revolutionized as if human nature itself were altered.” Such is the great importance of the law of diminishing returns.

And that’s because of a lesson from economics called the law of diminishing marginal utility (DMU). The law of DMU states that as you consume more and more of a good, at some point you will get less satisfaction (diminishing utility) from incremental (marginal) consumption.

We normally draw a PPF on a diagram as concave to the origin i.e. as we move down the PPF, as more resources are allocated towards Good Y the extra output gets smaller – so more of Good X has to be given up in order to produce Good Y; This is an explanation of the law of diminishing returns and it occurs because not all factor inputs are equally .

The law of diminishing returns indicates that the ratio of input and output is not constant.


For example, the additional sales generated with a $ advertising budget is not necessarily twice.

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