What does the law of diminishing average returns indicate?

The law of diminishing average returns, also known as the law of diminishing returns, suggests that as more units of a variable input (like labor) are added to a fixed factor of production (like machinery or land), the additional output produced by each additional unit of the variable input will eventually decrease after a certain point.

This principle reflects how, beyond a particular point of input, each new unit contributes less to output than the previous unit. For example, if a factory employs more workers while keeping the amount of machinery constant, initially, the output may increase significantly. However, as more workers are added, they may start to crowd each other or have less machinery to work with, leading to a situation where additional workers produce less and less additional output.

Understanding this concept is crucial in production theory and helps explain why simply increasing labor or other variable inputs does not guarantee proportionate increases in output. The correct answer accurately captures the essence of this economic principle.