Question

Answer the following question.
What is meant by "diminishing returns to a factor"? Discuss any two reasons for the operation of diminishing returns to a factor.

Answer 1

The diminishing returns to a factor depict a particular phase under the law of variable proportion. Under this stage, the returns to a variable factor input or the marginal product is diminishing in nature, thereby giving the name ‘diminishing returns to a factor’.

This can be better understood with the help of the given diagram.

Here, the Diminishing Returns to a Factor is the stage that starts from point K and continues till point B on the TP curve. During this stage, the TP increases but at a decreasing rate and attains its maximum point at B, where it remains constant. On the other hand (in figure ii), the MP curve continues to fall and cuts AP from its maximum point Z, where MP equals AP. When TP attains its maximum point, corresponding to it, MP becomes zero. AP, in this stage initially rises, attains its maximum point at Z and thereafter starts falling.
Reasons for Decreasing Returns to a Factor:

1. Fuller utilisation of fixed factor - In this stage, the fixed factor is utilised to its maximum level as more and more of labour inputs are employed.
2. Imperfect substitutability between labour and capital - The variable factors are an imperfect substitute for the fixed factor. Therefore, the firm cannot substitute labour for capital and as a result, diminishing returns take place.
3. Optimum Proportion/ Ideal Factor Ratio - The optimum proportion (or ideal factor ratio) is a fixed ratio in which the labour and capital inputs are employed. These factors will be the most efficient if they are employed as per the optimum proportion. If this proportion is disturbed (by combining more of labour inputs to the fixed units of capital), then the efficiency of the factors will fall, thereby leading to the diminishing returns to the factor.