please explain the law of diminishing returns
In: Economics
The top comment here will be the most concise and simple. Everything after that will be less so, and less accurate.
While it is called a “law” it is actually more just a general principle or expectation.
The “Law of Diminishing Returns” states that as you invest more resources into something the profits or benefits will reduce in proportion to the resources invested.
For example suppose you have a river which cannot be crossed. If you invest the minimum resources required to make a bridge then there is huge returns compared to the investment, since there is a big difference between being able to cross vs. not crossing at all. However if you invest more resources you can build a better bridge and allow more people to cross at once, or perhaps even allow vehicles to pass over. But the benefit of that improvement can be expected to provide less benefit per unit of resources spent than that initial investment.
Continuing on you can expect the benefit of transitioning from a $1 million bridge to a $10 million bridge to be significantly greater than transitioning from a $100 million bridge to a $110 million bridge. That is the general idea of the law of diminishing returns.
Imagine you have a small garden where you’re planting strawberries. At first, when you add a little bit of water and fertilizer, your strawberries grow a lot and you get a big bunch of them. You’re happy because your hard work is paying off!
But then, you think, “If a little bit of water and fertilizer makes my strawberries grow this much, what if I add even more?” So you keep adding more and more, expecting to get more strawberries each time.
At first, it does work, and you get more strawberries. But after a certain point, adding more water and fertilizer doesn’t make much difference. You add a lot more, but only get a few extra strawberries. That’s because the plants can only use so much water and fertilizer effectively; after that, it’s just too much for them.
The law of diminishing returns is like this: when you keep adding more of something (like water and fertilizer) to help improve something else (like the number of strawberries you get), there comes a point where adding more doesn’t help as much as it did at the start. It means there’s a sweet spot for how much effort, resources, or time you should use, and after that, it’s not as effective.
Timmy and his brother Billy build a lemonade stand in their front yard and sell a dozen cups of lemonade. Their customers include their own parents, neighbors, and a handful of joggers who pass by the house on their route. Timmy uses the money to build a second lemonade stand four blocks down, in front of a friend’s house, so each brother runs their own stand and covers a wider area. And instead of a dozen cups they sell… sixteen.
It turns out that expanding the business did gain access to new customers, thanks to new neighbors, but the joggers are the same people at both locations, and aren’t interested in buying a second cup right away. It might be more convenient for some to have a stand closer to their home, but some who lived near the new stand’s location were already perfectly happy walking to the original. Expansion has made the business more convenient for those existing customers, but that doesn’t make the brothers more money. Just because one stall sold a dozen cups, that doesn’t mean every new stall will add another dozen cups sold.
To bring this above the realm of five year olds briefly, there are also a lot of added expenses when you scale up a business. Shipping to transport goods between locations, a warehouse to store product to be shipped, marketing costs to keep those products from backing up, added layers of management since you can’t be multiple places at once, expanded customer service to keep up with transactions, insurance costs to cover a wider margin of error, etc. These things are sometimes referred to as logistics, or the cost of doing business.
So, as you make more products and get them out to more places, the demand for those products go down, while simultaneously, you end up paying more and more for each product that gets sold, in all sorts of little ways that can quickly add up.
You are thirsty and you have 10 bottles of water.
The first feels super nice and quenches your thirst.
The second one is still pretty nice but probably drinking slower and getting full.
The third one you can still down it but probably not pleasant anymore.
Etc
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