Diminishing Marginal Productivity

Article byPrakhar Gajendrakar
Reviewed byDheeraj Vaidya, CFA, FRM

Diminishing Marginal Productivity Definition

Diminishing marginal productivity in economics states that a small change in a variable input or a factor of production can initially create a small positive impact on the production output, and the positive impact starts reducing after a certain point.

This economic principle explains why production increases at a diminishing rate regardless of the increase in a specific input. It also explains the increase in the average cost of production along with the increase in productivity. Therefore, a producer needs to identify the point after which the change will start bringing adverse effects on the process and become inefficient.

Key Takeaways

  • The diminishing marginal productivity implies that a change in an input of a production process keeping others constant will only elevate the productivity slightly per unit.
  • Understanding the concept helps to increase productivity by finding the perfect mix of factors of production.
  • It helps identify the point where the rate of return or marginal productivity starts declining.
  • It causes if the production process involves fixed assets and becomes intense when inputs are limited in availability, and there is a low demand for the output, etc.

Law of Diminishing Marginal Productivity Explained

The law of diminishing marginal productivity states that when an additional unit of variable input or factor of production is introduced in a production process while keeping every other production factor constant, it will uplift the production by a smaller value per output unit. Also, continuing the introduction of additional input units will exhibit declining marginal productivity. In essence, increasing inputs without proper analysis causes diminishing marginal productivity or increases the cost of production.

Diminishing Marginal Productivity

The effect can be observed in manufacturing or production processes and everyday life. If a process or system performs at its optimal capacity, then increasing any input factor while maintaining other input factors constant will result only in an insignificant increase in input. Generally, it is a principle explaining one of the reasons behind declining productivity and accounted as a negative aspect because, in a business, it generally appears to raise the cost and lower the productive output after a certain extent.

Financial Modeling & Valuation Courses Bundle (25+ Hours Video Series)

–>> If you want to learn Financial Modeling & Valuation professionally , then do check this ​Financial Modeling & Valuation Course Bundle​ (25+ hours of video tutorials with step by step McDonald’s Financial Model). Unlock the art of financial modeling and valuation with a comprehensive course covering McDonald’s forecast methodologies, advanced valuation techniques, and financial statements.

Examples

Let us look into some examples of diminishing marginal productivity for better understanding:

  • A restaurant facing a problem with customer waiting time hires additional two servers to increase productivity. Also, an adequate number of restaurant staff is essential to improve productivity and service. The restaurant also hired an experienced chef to prepare complex dishes. Within months the result of hiring new staff was visible in the revenue figure. The restaurant is more organized now and running at optimal capacity. Motivated by the improvement in restaurant efficiency, the owner again hired two more servers and an experienced chef. However, the new addition didn’t cause a positive impact but increased the cost due to a salary increase. In essence, overstaffing caused a decline in productivity.
  • Cathy likes to drink coffee every morning, and she first has a cup of coffee before starting her day; she experiences instant rejuvenation from it. Again, when Cathy reaches her office, she takes another coffee at her desk. This coffee makes her feel good and happy, but not as much as the first. After an hour or so, she takes another cup of coffee; this time, she finds the coffee just all right and nothing much. So she resumes work, takes her lunch, and pours herself another cup of coffee. This time she drinks it anyway without any taste or need for it. It is a simple example of diminishing marginal productivity where Cathy is just having coffee one after another, and the level of satisfaction derived from drinking coffee declines gradually.

Causes

  • Fixed assets: At certain phases, to keep the momentum of increasing return, all or specific factors of production involved should be increased. But the existence of fixed inputs makes it difficult. It also occurs when the business or production has to deal with fixed assets like buying new equipment and machinery.
  • Economic scarcity: When the factors of production involve scarce resources like land and workers, the adjustment of production factors to increase the return rate will be disturbed.
  • Demand: It also depends on the manufactured product’s demand. If the capacity to produce is high but the demand is low, it will decrease the return.
  • Optimum production: When the additional inputs are introduced during a phase where the production process has the perfect mix of production and optimum production factors, it will have more chance of reducing productivity.

Frequently Asked Questions (FAQs)

What is diminishing marginal productivity?

It is the decline in marginal output or productivity of a manufacturing process when the quantity of a single factor of production is gradually raised, given all other factors of production stay constant.

What is the diminishing marginal productivity of labor?

The difference in production brought on by adding a new unit of labor is known as the marginal product of labor. The marginal product of labor may not always rise as the number of workers rises. When scaled incorrectly, the marginal output of labor may decrease as the workforce grows, and the phenomenon is known as decreasing marginal returns.

What is the diminishing marginal productivity of capital?

The increased production that a company experiences when it includes an additional unit of capital is known as the marginal product of capital. However, when the amount of capital rises, the production change becomes less substantial than before. Therefore, the falling marginal product indicates declining marginal returns. In addition, the value these more units provide to the firm in production tends to diminish since there aren’t enough workers to work with the new capital.

This has been a Guide to What is Diminishing Marginal Productivity. We explain the law of diminishing marginal productivity, examples, etc. You can learn more from the following articles – 

Reader Interactions

Leave a Reply

Your email address will not be published. Required fields are marked *