please explain the law of diminishing returns
In: Economics
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.
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