The Law of Diminishing Marginal Productivity: Concepts and Examples

What Is the Law of Diminishing Marginal Productivity?

The law of diminishing marginal productivity states that as the inputs to a productive process increase, the additional benefit tends to decrease. In other words, each additional dollar or unit of input yields slightly less benefit than the last.

Also known as the law of diminishing returns, this principle is important in determining an optimal allocation of resources. Production managers use it to decide how to invest their limited resources. For example, farmers may find that they can increase their crop yields with fertilizer, but the marginal gains tend to decrease as fertilizer is added.

Exploring the Implications of Diminishing Marginal Productivity

The law of diminishing marginal productivity involves marginal increases in production resulting from an increase of an input employed. It can also be known as the law of diminishing returns. In general, it aligns with economic theories like the diminishing satisfaction or utility from consuming more units of a product.

The law of diminishing marginal productivity suggests that managers find a marginally diminishing rate of production per unit of an input employed in the production process if all other things remain the same. When mathematically graphed this shows total production increasing at a decreasing rate as increasing units of an input are added to the production process.

Different than some other economic laws, the law of diminishing marginal productivity involves marginal product calculations that can usually be relatively easy to quantify. Companies might change production inputs mostly to manage costs. In some situations, it may be more cost-efficient to alter the inputs of one variable while keeping others constant.

However, in practice, all changes to input variables require close analysis. The law of diminishing marginal productivity says that these changes to inputs will have a marginally positive effect on outputs. Thus, each additional unit produced will report a marginally smaller production return than the unit before it as production goes on.

Marginal productivity or marginal product refers to the extra output, return, or profit yielded per unit by advantages from production inputs. Inputs can include things like labor and raw materials. The law of diminishing marginal returns states that when an advantage is gained in a factor of production, the marginal productivity will typically diminish as production increases. This means that the cost advantage usually diminishes for each additional unit of output produced.

When reviewing production to cost inputs, these calculations are important for businesses to consider.

Examples of Diminishing Marginal Productivity

Diminishing marginal productivity is often seen when one input costs less but increases production less. A decrease in the labor costs involved with manufacturing a car, for example, would lead to marginal improvements in profitability per car. However, the law of diminishing marginal productivity suggests that for every unit of production, managers will experience a diminishing productivity improvement. This usually translates to a diminishing level of profitability per car.

Diminishing marginal productivity can also involve a benefit threshold being exceeded. For example, a farmer using fertilizer for corn will find each added unit boosts production less until it stops helping. At the threshold level, the added fertilizer does not improve production and may harm production.

In another scenario consider a business with a high level of customer traffic during certain hours. The business could increase the number of workers available to help customers but at a certain threshold, the addition of workers will not improve total sales and can even cause a decrease in sales.

Integrating Economies of Scale With Diminishing Marginal Productivity

Economies of scale can be studied in conjunction with the law of diminishing marginal productivity. Economies of scale mean a company can often profit more per unit when producing in bulk. Mass production relies on key factors like labor, electricity, and equipment.

When these factors are adjusted, economies of scale still allow a company to produce goods at a lower relative per unit cost. However, adjusting production inputs advantageously will usually result in diminishing marginal productivity because each advantageous adjustment can only offer so much of a benefit. Economic theory suggests that the benefit obtained is not constant per additional units produced but rather diminishes.

Diminishing marginal productivity can also be associated with diseconomies of scale. Diminishing marginal productivity can potentially lead to a loss of profit after breaching a threshold. If diseconomies of scale occur, companies don’t see a cost improvement per unit at all with production increases. Instead, there might be no return, and losses can increase with more production.