Law of Diminishing Marginal Productivity

Law of Diminishing Marginal Productivity

What is the law of decreasing marginal productivity?

The law of marginal productivity reduction is an economic principle generally considered by managers in the management of productivity. In general, it indicates that the benefits from a slight improvement on the input side of the production equation will only increase slightly per unit and may stabilize or even decrease after a specific point.

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Law of marginal productivity reduction

Understanding the law of marginal productivity reduction

The law of the decrease in marginal productivity implies marginal increases in the output of production per unit produced. It can also be known as the law of decreasing marginal product or the law of decreasing marginal yield. In general, it aligns with most economic theories using marginal analysis. Marginal increases are commonly found in economics, showing a decreasing satisfaction or gain rate obtained from additional consumption or production units.

The law of marginal productivity reduction suggests that managers notice a slightly decreasing rate of return on production per unit of production after making advantageous adjustments to the inputs that stimulate production. When represented graphically, this creates a concave graph showing the total output of production gained from overall unit production gradually increasing until stabilization and potentially the beginning of the decline.

Different from some other economic laws, the law of the decrease in marginal productivity involves calculations of marginal products which can generally be relatively easy to quantify. Firms may choose to modify various inputs to the factors of production for a variety of reasons, many of which are cost-oriented. In some situations, it may be more cost-effective to modify the entries of a variable while keeping the other constants. However, in practice, all changes to the input variables require further analysis. The law of marginal productivity reduction says that these changes to inputs will have a slightly positive effect on outputs. Thus, each additional unit produced will display a production yield slightly lower than that of the previous unit as and when production.

The law of decreasing marginal productivity is also known as the law of decreasing marginal yields.

Marginal productivity or marginal product refers to production, output or additional profit generated per unit from the benefits of production inputs. Inputs can include things like labor and raw materials. The law of diminishing marginal returns stipulates that when an advantage is obtained in a factor of production, marginal productivity generally decreases as production increases. This means that the cost advantage generally decreases for each additional unit of production produced.

Key points to remember

  • The decline in marginal productivity generally occurs when advantageous changes are made to the input variables affecting total productivity.
  • The law of marginal productivity reduction stipulates that when an advantage is obtained in a factor of production, the acquired productivity of each subsequent unit produced will increase only slightly from one unit to another.
  • Production managers take into account the law of decreasing marginal productivity when improving variable inputs to increase production and profitability.

Examples from the real world

In its most simplified form, the decrease in marginal productivity is generally identified when a single input variable presents a decrease in the cost of inputs. Lower labor costs from making a car, for example, would lead to marginal improvements in profitability per car. However, the law of marginal productivity reduction suggests that for each unit of production, managers will experience an improvement in decreasing productivity. This usually results in a lower level of profitability per car.

The decrease in marginal productivity can also lead to a benefit threshold being exceeded. For example, consider a farmer using fertilizer as an input in the process of growing corn. Each unit of fertilizer added will only slightly increase the production yield up to a certain threshold. At the threshold level, the added fertilizer does not improve production and can affect production.

In another scenario, consider a business with a high level of customer traffic for certain hours. The company may increase the number of workers available to assist customers, but at a certain threshold, adding workers will not improve total sales and may even result in lower sales.

Considerations for economies of scale

Economies of scale can be studied in conjunction with the law of diminishing marginal productivity. Economies of scale show that a company can generally increase its profit per unit of production when it produces goods in large quantities. Mass production involves several important factors of production such as labor, electricity, use of equipment, etc. When these factors are adjusted, economies of scale always allow a business to produce goods at a lower relative unit cost. However, the adjustment of production inputs will generally lead to a decrease in marginal productivity, since each advantageous adjustment can only offer such a benefit. Economic theory suggests that the advantage obtained is not constant per additional unit produced but rather decreases.

The decrease in marginal productivity can also be associated with diseconomies of scale. The decrease in marginal productivity can potentially lead to a loss of profit after crossing a threshold. In the event of diseconomies of scale, companies do not notice any improvement in costs per unit with the increase in production. Instead, there are no returns earned for units produced and losses may increase as more units are produced.

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