Law of Diminishing Marginal Productivity

What Is the Law of Diminishing Marginal Productivity?

The law of diminishing marginal productivity is an economic principle usually considered by managers in productivity management. Generally, it states that advantages gained from slight improvement on the input side of the production equation will only advance marginally per unit and may level off or even decrease after a specific point. 

Understanding the Law of Diminishing Marginal Productivity

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

The law of diminishing marginal productivity suggests that managers find a marginally diminishing rate of production return per unit produced after making advantageous adjustments to inputs driving production. When mathematically graphed this creates a concave chart showing total production return gained from aggregate unit production gradually increasing until leveling off and potentially starting to fall.

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 may choose to alter various inputs in the factors of production for various reasons, many of which are focused on 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.

The law of diminishing marginal productivity is also known as the law of diminishing marginal returns.

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.

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Real-World Examples

In its most simplified form, diminishing marginal productivity is typically identified when a single input variable presents a decrease in input cost. 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, consider a farmer using fertilizer as an input in the process for growing corn. Each unit of added fertilizer will only increase production return marginally up to a threshold. 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.

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 usually increase their profit per unit of production when they produce goods in mass quantities. Mass production involves several important factors of production like labor, electricity, equipment usage, and more. 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 is no return gained for units produced and losses can mount as more units are produced.