March 23, 2018 

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RATE OF RETURN: The ratio of the additional annual income or profit generated by an investment to the cost of the investment. Here's a simple example, although the calculations are usually a great deal more involved for actual investments. If the cost of constructing a new factory is $10 million and it gives you an extra $1 million in profit each year, then its rate of return is 10 percent.

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In the short-run production of a firm, an increase in the variable input results in a decrease in the marginal product of the variable input. Decreasing marginal returns typically surface after the first few quantities of a variable input are added to a fixed input. This is one of two types of marginal returns. The other is increasing marginal returns. A related phenomenon is diseconomies of scale associated with long-run production.
Decreasing marginal returns occurs when the addition of a variable input (like labor) to a fixed input (like capital) causes the variable input to be less productive. In other words, two workers are less than twice as productive as one worker and four workers are less than twice as productive as two workers. Decreasing marginal returns means that the marginal product of the variable input decreases.

How about an example to illustrate decreasing marginal returns? Suppose that Flex-Star Plaque Company. produces the wildly popular Flex-Star Interactive Trophy Plaque (the wall plaque that broadcasts accomplishments to any who pass by). The Flex-Star factory, located on the outskirts of Shady Valley, is filled with the machinery, tools, and equipment--the fixed capital inputs--needed to produce Interactive Trophy Plaques.

  • The Flex-Star factory currently employs six workers (Dan, Deanna, Doug, Debra, Donnie, and Duncan) who are busily engaged in Trophy Plaque production. By dividing the tasks and effectively using the Flex-Star factory and related equipment, these six workers encounter increasing marginal returns. Dan cuts the wood. Deanna does the sanding. Doug programs the voice modulator. Debra polishes the metallic-looking plastic figurine. Donnie does the packing. And Duncan is in charge of shipping.

  • The factory currently turns out 100 plaques an hour, but demand is growing and Flex-Star needs even more production. Because the Flex-Star factory and associated capital is fixed in the short run, the only option is to hire more workers. So onto the payroll comes Barbara, Brian, Bruce, and Becky. The curious thing about this second batch of B-workers is that they are increasingly LESS productive than the original D-workers. Is this because they are less skilled? Absolutely not. The Ds have the same skills, training, and experience as the Bs.

  • No, the answer to this productivity mystery rests with the fixed capital. The original D-workers perform the critical tasks (programming, polishing, packing, etc.) needed to produce Interactive Trophy Plaques. The B-workers can boost total plaque production by assisting the Ds, fetching materials and equipment used by the Ds, and taking over when the Ds are on lunch and coffee breaks.

    But because the size of the Flex-Star factory and the amount of capital it contains are fixed, there is only so much that the Bs can do. Barbara cannot use the table saw at the same time Dan is using the table saw. There is only one table saw. While total plaque production increases with the addition of each B-worker, the incremental boost in production declines with each additional B-worker.

The end result is decreasing marginal returns. In other words, the marginal product of each worker is less than the previous worker. This is what creates the downward-sloping segment of the marginal product curve.


Recommended Citation:

DECREASING MARGINAL RETURNS, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2018. [Accessed: March 23, 2018].

Check Out These Related Terms...

     | law of diminishing marginal returns | marginal returns | increasing marginal returns | production inputs | production function | production time periods | total product | average product | production stages |

Or For A Little Background...

     | short-run production analysis | marginal product | long run, microeconomics | short run, microeconomics | fixed input | variable input | product | production | production cost | variables | labor | capital | law of supply | supply | supply price | quantity supplied | principle | business | economic analysis | marginal analysis | factors of production | microeconomics | market |

And For Further Study...

     | long-run production analysis | law of diminishing marginal utility | marginal utility | division of labor | production possibilities | law of increasing opportunity cost | total product and marginal product | total product and average product | average product and marginal product | returns to scale | marginal productivity theory | marginal cost | marginal revenue product |

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