What is the law of diminishing returns?

The law of diminishing returns refers to the phenomenon in production where, after a certain point, adding more of one input (while keeping other inputs constant) leads to a smaller increase in output. This means that as more resources, such as labor or materials, are added to a fixed amount of capital or land, the additional output gained from those resources will eventually start to decline.

In practical terms, this principle indicates that there are optimal levels of input that maximize output. Once those levels are exceeded, the efficiency begins to drop, demonstrating that while increasing inputs can lead to increased production, there is a limit to the benefits that can be derived from those inputs. Understanding this concept is crucial for effective decision-making regarding resource allocation in production, as it helps to avoid over-investment in any single resource.