Law of Diminishing Returns

The Law Of Diminishing Marginal Returns

The law of diminishing returns states that in the short term, employing more workers will lead to declining marginal productivity. Because capital is fixed, employing extra workers causes them to have lower marginal product.

Definitions

Total Product (TP) This is the total output produced by workers
Marginal Product (MP) This is the output produced by an extra worker.

Law of Diminishing Marginal Returns

· Diminishing Returns occurs in the short run when one factor is fixed (e.g. Capital)

· If the variable factor of production (e.g. labour) is increased, there will come a point where extra workers become less productive than previous workers. Therefore, these extra workers will have a lower marginal product.

Why does diminishing returns occur?

This is because, if capital is fixed, extra workers will eventually get in each other’s way as they attempt to increase production. E.g. think about the effectiveness of extra workers in a small café. If more workers are employed, production could increase but more and more slowly. However, there are only so many chopping boards and space to make sandwiches. An extra worker may just struggle to find a space to make sandwhiches.

· This law only applies in the short run because in the long run all factors are variable (e.g. you can build a bigger cafe)

Example of Diminishing Returns

Q of workers	TP	AP	MP
1	5	5	5
2	15	7.5	10
3	20	6.6	5
4	23	5.7	3
5	21	4.2	2
6	20	3.2	1

In the above example, diminishing returns is said to occur when the third worker is employed.
The third worker has a marginal product of 5 - which is less than the marginal product (MP) of the second worker (10).

Diminishing Returns and Marginal Cost (MC)

· Assume the wage rate is £10., Therefore, each extra worker will costs £10.

· The Marginal Cost (MC) of a sandwich will be the cost of the worker divided by the number of extra sandwiches that are produced.

Q of workers	TP	AP	MP	MC
1	5	5	5	2
2	15	7.5	10	1
3	20	6.6	5	2
4	23	5.7	3	3.3
5	21	4.2	2	5
6	20	3.2	1	10

The first worker, costs £10 and produces 5 sandwiches. Therefore, the MC of each sandwich is £2.
The second workers produces an extra 10 sandwiches. Therefore, the MC of these is just £1.
However, the sixth worker employed, only manages to produce one extra sandwich. Therefore, this sandwich has a high MC of £10.
Therefore as MP increases MC declines and vice versa.

Examples of Diminishing Returns

A good example of diminishing returns is the use of chemical fertilizers- a small quantity of fertiliser can lead to a big increase in output for a farmer. However, increasing its use further may lead to declining marginal product (MP) as the efficacy of the chemical declines.