Diminishing Marginal Returns
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Suppose that one kilogram of seed applied to a plot of land of a fixed size produces one ton of crop. You might expect that a 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) 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.
This particular example of Diminishing Marginal Returns in formulaic terms: Where = Diminished Marginal Return, = seed in kilograms, and = crop yield in tons gives us:
Substituting 3 for and expanding yields:
Another example is a factory that has a fixed stock of capital, or tools and machines, and a variable supply of labor. As the firm increases the number of workers, the total output of the firm grows but at an ever-decreasing rate. This is because after a certain point, the factory becomes overcrowded and workers begin to form lines to use the machines. The long-run solution to this problem is to increase the stock of capital, that is, to buy more machines and to build more factories.
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