Question

Think of an example to explain the law of diminishing returns. Please explain how this relates to a specific industry.

Answer 1

Law of diminishing return or Diminishing marginal return explains that in a production process if one variable input is increased and other things are kept constant there will be a point after which the marginal increase of output relative to that variable will start decreasing.  

Example: Let's take an ice cream parlor for example. In an ice cream parlor, we have one ice cream making machine and two labor to use it. Those two labor are making 10 units of ice cream every day. If the number of people working is increased to 3 the output produced is increased to 15 but if 4 labor is used keeping the number of machines constant the output increased to only 16 i.e. increase of one unit of labor leads to an increase of only 1 extra unit of ice cream and any more labor hired will not increase the output at all.

Here, we have kept other variable like capital and technological development as constant and only increased the labor input for producing an ice cream. After a point, the number of output per labor decreased showing diminishing return.

In a particular industry, we generally have limited capital and technological development in the short run and only a limited variable like labor can be changed to increase the production, but after a point, it reaches diminishing return and with given resources (capital and tech) only a limited amount of labor can be hired, If there was no law of diminishing return a single industry can hire as many labors or a variable factor as they want without needing to change any other factor.