The Law of Diminishing Returns

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The Law of Diminishing Returns

  • The law of diminishing returns refers to te process when a variable factor increase, when factors stay fixed 
  • Because at least factor stays fixed, the law of diminishing returns applies in the short run
  • Output increases are limited by diminishing returns in the short run 
  • Marginal product is the additional output produced by adding one more unit of a factor input
  • Initially, as you add more of a factor of production, the marginal product will increase, as each unit of output added will add more than the one before
  • This may be due to specialisation, because more is possible with more of a particular force 
  • Eventually, if you keep adding units of one factor of production, the other fixed factors will begin to limit the additional output, and the marginal product will begin to fall 
  • This is known as the point of diminishing returns (where marginal product increases as input increases) 
  • The law of diminishing returns is 
  • "IF ONE VARIABLE FACTOR OF PRODUCTION IS INCREASED WHILE OTHER FACTORS STAY FIXED, EVENTUALLY THE MARGINAL RETURNS FROM THE VARIABLE FACTOR WILL BEGIN TO DECREASE" 
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Increasing Marginal Cost

  • Marginal returns are related to marginal cost 
    • as marginal returns rise, marginal cost falls 
    • as marginal returns fall, marginal costs rise
  • Marginal cost will rise as marginal returns fall because, if all other things are equal, if you're getting less additional output from each unit of input then the cost per unit of the output will be greater
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Productivity falling

  • The law of diminishing returns states that as the level of a variable input increase, marginal product will begin to fall 
  • As the level of that factor input continues to be increased, the average product will fall too. The Marginal Product curve always meets the Average Product curve when the Average Product curve is at its maximum 

Average product is the output produced per unit of factor input 

  • The average product is also known as productivity 
    • e.g. if the variable factor is labour, the labour productivity is number of units per worker (per hour) 
    • So if a firm employs more and more people, it will find that productivity will eventually fall 
  • If a firm then adds more of a variable factor, it is possible to add further input with a fall in total produce 

Total product is the total output produced using a particular combination of factor inputs 

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How to improve productivity

There are many ways a firm can improve productivity 

  • better training and management 
  • improved technology can hep improve productivity 
  • increasing productivity will help a firm reduce its costs of production 
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