Diminishing Returns - Returns and Costs

Returns and Costs

There is an inverse relationship between returns of inputs and the cost of production. Suppose that a kilogram of seed costs one dollar, and this price does not change. Although there are other costs, assume they do not vary with the amount of output and are therefore fixed costs. One kilogram of seeds yields one ton of crop, so the first ton of the crop costs one dollar to produce. That is, for the first ton of output, the marginal cost of the output is $1 per ton. If there are no other changes, then if the second kilogram of seeds applied to land produces only half the output of the first, the marginal cost would equal $1 per half ton of output, or $2 per ton. Similarly, if the third kilogram of seeds yields only a quarter ton, then the marginal cost equals $1 per quarter ton, or $4 per ton. Thus, diminishing marginal returns imply increasing marginal costs and rising average costs.

Cost can also be measured in terms of opportunity cost. In this case the law also applies to societies – the opportunity cost of producing a single unit of a good generally increases as a society attempts to produce more of that good. This explains the bowed-out shape of the production possibilities frontier.