Diminishing Returns Definition

The law of diminishing returns is an economic principle that states that after a certain point, adding more of a input (like labor or investment) will yield progressively smaller output or return. In other words, there is a point at which the marginal product (output per unit of input) begins to decline. The law applies in situations where there are increasing costs associated with additional units of production.

The law of diminishing returns is also sometimes referred to as the law of diminishing marginal utility or the principle of diminishing marginal productivity. It’s important to note that the law only applies to inputs that are variable, meaning they can be increased or decreased in quantity. Fixed inputs, like land or capital, are not subject to the law because they cannot be changed in quantity.

The concept of diminishing returns is often used in business to help make decisions about how to allocate resources efficiently. For example, a company might decide to invest more money in advertising if it believes that the extra expenditure will result in additional sales. But if those sales only marginally offset the cost of the advertising, then it might not be worth it from a financial perspective. In this case, the company would be said to have reached the point of diminishing returns with respect to advertising.