I will use 3 terms to explain the law of diminishing returns, total output, average output and marginal output. The total output is the total product generated by the factors of production. The average output is the total output divided the number of units of the variable factor of production, which in this case are workers. Finally the marginal product is the change in total output when an extra unit of the factor of production is employed (worker).
A numerical example might be as follows:
In this example, we can see how initially the marginal output is rising. It peaks when the 5th worker is employed, where the marginal output is 30. Then marginal output start to fall and total output is still increasing, but at a slower rate. At this point is when diminishing returns take place, when workers start to get into each other’s way, decreasing the output per worker.
The average output will continue to rise as long as the marginal output is greater than the average. Once the marginal output is below the average as is in the 5th worker employed, then the average will start to decline onwards.
The law of diminishing returns can help businesses, which want to maximise their output by minimising their costs. For example, if a business owned the units stated above, they wouldn’t employ the 8th worker, and might don’t employ the 7th, depending the costs of making the product.
