The law of diminishing returns is a very old economic law. The classical economics like Adam Smith, David Ricardo and Malthus associated the law of Diminishing Returns to agriculture. Marshall believed that production is governed by three different laws of production corresponding to three different production functions. It is the common human experience that a repeated use of piece of land will yield less and less product.
If a cultivator goes on cultivating a unit of land applying more and more of capital and labour, the total product will not increase proportionate to the doses of capital and labour applied. If the produce increased proportionate to the increase in the doses of labour and capital, the food problem of the whole country would be solved from a tingle plot of land. The return becomes less than proportionate despite the application of more and more labour and capital.
If the additional doses of capital and labour applied to the same plot of land, marginal return diminishes but the total return diminishes at a diminishing rate. According to Marshall "An increase in the amount of capital and labour applied in the cultivation of land causes in general a less than proportionate increase in the Mount of produce raised unless it happens to coincide within an improvement in the art of agriculture."
According to the law of diminishing return each dose of capital and labour, after a point will yield less returns than the preceding dose. The first dose of capital and labour yields 10 Quintals of product but just after first dose and from the 2nd dose marginal product diminishes from 5 quintals to 2 quintals.
The cultivator increases the additional doses and the additional doses employed on the land will lead to total production to rise at a diminishing rate and marginal return to fall. Average product continues to fall from 10 quintals to 4.8 quintals.
Along OX-axis is measured dose of labour and capital and along OY-axis marginal return is represented. As the doses of labour and capital are applied marginal return will gradually fall. In other word marginal return diminished with every additional doses of variable factors.
Assumptions of the law:
1. Factor proportions are changeable. It is possible to change the ratio of the variable factor the fixed factors of production.
2. The law holds good in the short-run.
3. Variable factors are assumed to be identical.
4. Prices of variable factors do not change.
5. Technique of production remains unchanged,
Reasons for operation of the law:
(i) Inelasticity (fixity) supply of some factors:
It is the fixity of the supply of land which sets the law of diminishing return in motion. In short period some factors are fixed and given. When other variable factors are combined with this factor in increasing proportions, this fixed factor is distribute on the units of variable factors. After an ideal combination the proportion of variable factors to fixed factors become high. That is why diminishing return occurs.
(ii) Imperfect substitutes:
According to Mrs. Joan Robinson the factors of production are imperfect substitute for one another. Capital can be substituted for labour to some extent but cannot do perfectly. If these factors were perfect substitutes for one another, the returns would not diminish. The greater the imperfection in substitution of one factor for another, the faster shall be the fall in marginal return.
(iii) Optimum Proportion:
Factors are combined in a proportion which is given. No other combination will be more efficient than this. If this proportion is disturbed, the efficiency of factors will fall giving rise to diminishing returns.
(1) The art of agriculture should not change. The law of diminishing return will not hold good if the cultivator continues to use improved seeds, fertilizers, and modern agricultural implements.
(2) The law may not operate in case of land which is cultivated for the first time. If a new land is taken to cultivation, it will yield increasing return for the first few years.
(3) If the quantity of variable factors are less than the optimum portion, the productivity of labour and capital may increase the sometime.