Law of Diminishing Returns:

The Law of Diminishing Returns states that other things being equal - e.g. given technology, socio-cultural environment, etc. - as more and more units of a variable input (say labour) are employed in combination with a fixed input (say capital), initially MP increases but eventually it diminishes.

The following are the conditions under which the law operates:

(i) The law is a short-run phenomenon where the producer uses fixed and variable inputs. All other inputs, apart from the variable input are held fixed in quantity.

(ii) The variable factor may be any input usually used in production (e.g. labour).

(iii) The variable factor is applied unit by unit, and each unit is identical in quantity and quality.

(iv) It applies in any sector production such as agriculture, manufacturing retailing, advertising, mining etc.

It is a law that describes the behaviour of the marginal product (MP). Therefore it is the MP that eventually diminishes and it does so only after increasing. When fixed and variable inputs are combined to produce a product, the fixed input (capital) helps the variable input (labour). The marginal output of the variable input depends on the amount of the fixed input the variable input has received. In the first instance, if the amount of the fixed input received by the variable factor is relatively plentiful marginal output of the variable factor increases. In the second instance, as the variable input beyond a certain unit, they obtain less and less amounts of the fixed input to combine with which leads to decrease in marginal output. Each extra unit of the variable input adds less and less to total product. In the third instance, if the employment of more and more units of the variable input continues, there will be a cluster of the variable input such that the amount of fixed input each unit of variable input gets to combine with becomes insignificant, the turns negative.

In summary, there is a certain optimum combination of fixed and variable inputs which when exceeded will bring about diminishing returns. The law of diminishing returns to variable proportion is important because it helps the producer to determine the best proportion in which to employ the fixed and variable inputs. If the MP is increasing it means there is too much of the fixed input in combination with the variable input. If the MP falls to zero, there is too little of the fixed input. This guides the producer in determining the best proportion between the fixed and variable inputs.