The law of diminishing returns, also referred
to as the law of diminishing marginal returns
or the principle of diminishing marginal productivity,
simply states that increases in one factor
of production generate lower and lower additional
returns, assuming that nothing changes when
it comes to the other factors of production.
Let's imagine Bill starts a small restaurant
and only has one waiter. The food is tasty,
the restaurant looks nice but with only one
waiter, customers are not happy with the long
wait times and quite a few don't return. As
a result, Bill's monthly profit is an unsatisfactory
$4,000 and he decides to take action by hiring
another waiter.
Yes, he has to pay another person but now,
his restaurant is actually efficient and profits
go up because his revenue increase more than
covers the salary of the waiter, with his
monthly profit jumping to $6,000. Bill then
decides to hire another waiter and, again,
it works because his profit goes up... just
not as dramatically as before. Still, it goes
from $6,000 to $6,500. Bill likes the trend,
so he hires yet another waiter but this time,
his profit actually goes down by $1,000, now
sitting at $5,500. As can be seen, adding
the fourth waiter was just not worth it because
as of a certain point, too many waiters just
end up being in the way of one another.
That's pretty much it.
To re-balance the equation, Bill would have
to either let one of the waiters go or implement
changes when it comes to other factors of
production by for example getting a larger
space.
