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A SIMPLE EXAMPLE Suppose that one kilogram (kg) of seed applied to a plot of land of a fixed size produces one tonne of harvestable crop. You might expect that an ''additional'' kilogram of seed would produce an additional tonne of output. However, if there are diminishing marginal returns, that additional kilogram will produce less than one additional tonne of harvestable crop (on the same land, during the same growing season, and with nothing else but the amount of seeds planted changing). For example, the second kilogram of seed may only produce a half tonne of extra output. And diminishing marginal returns also implies that a third kilogram of seed will produce an additional crop that is even less than a half tonne of additional output. Assume that it is one quarter of a tonne. In economics, the term "marginal" is used to mean on the edge of productivity in a production system. The difference in the investment of seed in these three scenarios is one kilogram — "marginal investment in seed is one kilogram". And the difference in output, the crops, is one tonne for the first kilogram of seeds, a half tonne for the second kilogram, and one quarter of a tonne for the third kilogram. Thus, the Marginal Physical Product (MPP) of the seed will fall as the total amount of seed planted rises. In this example, the marginal product (or return) equals the extra amount of crop produced ''divided by'' the extra amount of seeds planted. A consequence of diminishing marginal returns is that as total investment increases, the total return on investment ''as a proportion'' of the total investment (the ''average'' product or return) also decreases. The return from investing the first kilogram is 1 t/kg. The total return when 2 kg of seed are invested is 1.5/2 = 0.75 t/kg, while the total return when 3 kg are invested is 1.75/3 = 0.58 t/kg. A LAW? The "law" of diminishing marginal returns says that after a possible initial increase in marginal returns, the MPP of an input will fall as the total amount of the input rises (holding all other inputs constant). The "law" is far from universal in its validity, though there are many examples. For example, most people find that listening to the same piece of music over and over again during a day implies that each additional hearing is less pleasant than the previous one, at least after the initial stage of gaining familiarity with the piece. This is an example of diminishing Marginal Utility of the piece. (Case & Fair, 1999: pp. 135-137). The usual argument in favor of diminishing marginal ''physical'' returns is in terms of crowding: if you put too many seeds (or too much fertilizer) in the ground, eventually each additional increment pays off less than previous ones. Returns and costs There is an inverse relationship between returns of inputs and the cost of production. Suppose that a kilogram of seed costs one euro (€), and this price does not change. There are also other costs, but assume they do not vary with the amount of output. (They are Fixed Cost s.) That means that the first ton of the ''crop'' cost one extra € to produce. That is, for the first ton of output, the Marginal Cost (MC) of the output is 1 €/t. If there are no other changes, then if the second kg of seeds applied to land produces only 1/2 extra ton of output, the MC equals 1 € per 1/2 t of output, or 2 € per ton. Similarly, if the third kilogram produces 1/4 extra ton, then the MC equals 1 € per 1/4 ton, or 4 € per ton. Thus, diminishing marginal returns imply ''increasing Marginal Cost s.'' This also implies rising ''average'' costs. In this numerical example, average cost rises from 1 € for 1 ton to 2 € for 1.5 tons to 3 € for 1.75 tons, or from 1 to 1.333 to 1.71 € per ton (approximately). In this example, the Marginal Cost equals the extra amount of money spent on seed ''divided by'' the extra amount of crop produced, while Average Cost is the total amount of money spent on seeds ''divided by'' the total amount of crop produced. Cost can also be measured in terms of Opportunity Cost . RETURNS TO SCALE Note that the marginal returns discussed in this article refer to cases when only ''one'' of many inputs is increased (for example, the quantity of seed increases), but the amount of land remains constant. If all inputs are increased in proportion, the result is generally constant or increased output. (''Cf.'' Economies Of Scale .) HISTORY The concept of diminishing returns can be traced back to the concerns of early economists such as Thomas Malthus and David Ricardo . Both men, who lived in 19th Century England , were worried that land, a factor of production in limited supply, would lead to diminishing returns. In order to increase output from Agriculture , farmers would have to farm less fertile land or farm existing land with more intensive production methods. In both cases, the returns from agriculture would diminish over time, causing Malthus and Ricardo to predict population would outstrip the capacity of land to produce, causing a Malthusian Catastrophe . (Case & Fair, 1999: 790). SEE ALSO REFERENCES
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