Explain the law of diminishing marginal returns.

The law of diminishing marginal returns states that as output increases, the efficiency of production falls, leading to higher average costs. This happens because if marginal costs are higher than average costs, then average cost is being pulled up. This phenomenon occurs only in the short run when at least one factor of production is fixed, such as capital.

When a variable factor, like labour, is increased, eventually productivity starts to fall because the fixed factor is being overworked. Adding more variable factors of production will increase returns only for a limited period. After this period, the benefits of specialisation are eroded, and productivity decreases. For example, extra workers may start getting in each other's way or have to share tools, reducing overall efficiency.