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Law of Diminishing Returns Law of Diminishing Returns

Law of Diminishing Returns

Think back to the last time you overindulged in a huge, delicious dessert. It’s likely that the first bite was divine, but perhaps the subsequent bites left you wondering whether you’d regret overeating, and the final few bites might have just left you feeling sick. If you’ve had that experience, congratulations! You’ve gained a physical understanding of this model.  The Law of Diminishing Returns predicts that increasing one variable in a production process, while keeping the others constant, might initially increase output but, after a point, will result in smaller returns. Put simply, too much of a good thing will, eventually, return less value.  AN ECONOMICS MAINSTAY. Also known as the Law of Diminishing Marginal Returns, this model is a foundational economic principle typically applied to production decisions and planning. It has a number of assumptions, primarily around factors such as technology remaining constant — See Limitations below for more.  The Law of Diminishing Returns predicts that new inputs will progress through a cycle of increasing returns, followed by diminishing returns, and will finally result in negative returns. You can view it in conjunction with the Fixed versus Variable Cost model, as typically Fixed factors will remain constant (e.g. building size) while a variable factor will be increased (e.g. labour) when seeking greater value. However, the fixed factor will provide limitations to growth over time. For example, only so many employees (variable cost) can work effectively in a given building (fixed cost). In addition to fixed costs, other causal factors behind this ‘law’ might include limited demand, lower productivity returns, and the negative impact on parallel factors.  BROAD APPLICATIONS. The Law of Diminishing Returns can be applied to almost anything, on an economic,  personal, or societal level, that involves input to create value. For example:  Hiring new employees in a shop, at first might return more sales before the returns trail away.  When developing a new skill, you’ll find quick progress initially then, at a certain point, each hour you invest will result in less progress.  If you are farming a piece of land, fertiliser will help to maximise your outputs but, at a certain point, more fertiliser will not return more produce. Working longer hours might deliver greater work success to a point, but will likely be counterproductive over time.  An hour meeting with a group of people might return important results, but extending it to a two-day workshop won’t necessarily provide exponential returns.  Launching a marketing campaign on Google? Paying x amount might see strong click-throughs, but investing exponentially more won’t necessarily result in equivalent exponential growth.  Sleeping longer at night will make you feel more energised and healthy but, after a certain point, extra sleep will stop returning noticeable benefits.  IN YOUR LATTICEWORK.  This model can be seen as a negative version of the Pareto Principle and involves a Tipping Point which indicates the beginning of Diminishing Returns. One way to get the most of your high return phase is to apply Parkinson's Law, and Timebox your investment before you reach Diminishing Returns. The Law of Diminishing Returns offers a stark contrast to Compounding, and it could be argued that progress will tend to either follow one or the other rather than continue in a consistent, straight trajectory.  One of the reasons why you might continue to invest time or money into Diminishing Returns is the Sunk Cost Fallacy. And finally, better understand models such as Deliberate Practice and the Paradox of Choice with your understanding of Diminishing Returns. 

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