top of page

Law of Diminishing Marginal Return

The choice of the producer (or company) can be based not only on the nature of the production combination but also on the volume of production (the quantities to be produced).

Law of Diminishing Marginal Return

Economies of scale account for increasing returns, which involve lowering the average cost (or cost price) by increasing the quantities produced. In fact, producing more makes it possible to reduce unit cost prices, in particular through the greater compensation of fixed costs. The larger the company, the more efficient (productive) it is because it can spread fixed costs over a greater number of products.

Software production is often given as an illustration because the cost of production is made up of fixed costs (salaries, premises, facilities, etc.). Software produced to be sold, even if the quantity increases, does not significantly influence the total cost. On the other hand, the more sales increase, the more the weight of fixed costs decreases. The average cost (or cost price), in a way, tends to go towards zero when the number of products sold tends towards infinity.

The graph illustrates:

Increasing returns, which are represented by the left-hand sides of the graphs before the point of intersection between the average and marginal cost curves. The point of intersection where the marginal cost curve (MC) intersects the average cost curve (AC) at its minimum, corresponds to the equation MC = AC or the production optimum.

Decreasing returns, on the other hand, illustrate the increase in average cost when quantities continue to increase and marginal cost becomes higher than average cost. They are represented by the right-hand sides of the graphs after the point of intersection.

The law of diminishing returns illustrates the fact that an increase in one factor, with the others remaining fixed, results in an increase in unit cost. It is accompanied by decreasing marginal productivity. David Ricardo, a 19th century economist, gives the example of the use of marginal land which has a decreasing productivity and results in a decreasing marginal rent. The explanation is quite simple: a new piece of land to be exploited may be further away than the first ones and would then incur additional costs of travel, surveillance, maintenance, etc., which reduce its attractiveness. This law of diminishing returns can only be overcome if productivity increases faster than the cost and this can be made possible by the integration of new technological progress (TP)... Ricardo's pessimistic or fatalistic view of long-term growth is thus rejected.

The producer's choice can take into account the costs and revenues generated by sales: or the total revenue.

bottom of page