Production, Productivity and the Law of Diminishing Returns
Production is the process of converting factor inputs, land, labour, capital and enterprise, into outputs of goods and services.
Before you start
Make sure you're comfortable with these topics first:
Method
- Define production, converting inputs into outputs, and productivity, output per unit of input, e.g. output per worker for labour productivity.
- Distinguish the short run, at least one factor of production is fixed, from the long run, all factors of production are variable, a definition about the decision-making horizon, not a fixed period of calendar time.
- Define total product (total output from a given combination of inputs), average product (total product divided by the number of units of the variable factor) and marginal product (the extra output from one more unit of the variable factor).
- State the law of diminishing marginal returns: as successive units of a variable factor are added to a fixed factor, the marginal product of the variable factor will eventually fall.
- Explain the mechanism: each extra worker has a smaller share of the fixed factor, e.g. machinery or floor space, to use, so beyond some point they add less extra output than the workers before them, even though total product may still be rising.
- Distinguish diminishing marginal returns, the marginal product of the variable factor falling, from negative returns, marginal product becomes negative so total product actually falls, e.g. from overcrowding.
- Link diminishing marginal returns to short-run cost curves: as marginal product falls, the marginal cost of producing extra output rises, because it takes more of the variable factor to produce each additional unit.
Worked example
A market gardener has a fixed plot of land. Adding workers to harvest the crop gives the following total product, crates of vegetables per day: 1 worker = 10 crates, 2 workers = 22 crates, 3 workers = 32 crates, 4 workers = 38 crates, 5 workers = 40 crates. Calculate the marginal product of each worker from the second to the fifth, and identify the point at which diminishing marginal returns sets in.
- Marginal product of the 2nd worker = 22 - 10 = 12 crates.
- Marginal product of the 3rd worker = 32 - 22 = 10 crates.
- Marginal product of the 4th worker = 38 - 32 = 6 crates.
- Marginal product of the 5th worker = 40 - 38 = 2 crates.
- List the marginal products in order: 12, 10, 6, 2 - marginal product rises from the 1st to the 2nd worker (10 to 12) then falls continuously from the 3rd worker onward, so diminishing marginal returns sets in from the 3rd worker.
Practice questions
Try each question, then tap to reveal the answer.
Q1Define labour productivity.Show answer
Answer: Output per worker (or per worker-hour), calculated as total output divided by the number of workers (or worker-hours) employed.
Q2What defines the short run in economics?Show answer
Answer: The period in which at least one factor of production is fixed, typically capital, while other factors, e.g. labour, can be varied.
Q3What defines the long run?Show answer
Answer: The period in which all factors of production are variable, so a firm can change the scale of every input, including capital.
Q4What is marginal product?Show answer
Answer: The extra output produced by employing one more unit of the variable factor of production, e.g. one more worker.
Q5State the law of diminishing marginal returns.Show answer
Answer: As successive units of a variable factor are added to a fixed factor, the marginal product of the variable factor will eventually fall.
Q6A factory's total product is 100 units with 9 workers and 108 units with 10 workers. What is the marginal product of the 10th worker?Show answer
Answer: 108 - 100 = 8 units.
Q7Explain the difference between diminishing marginal returns and negative returns.Show answer
Answer: Diminishing marginal returns means marginal product is falling but still positive, so total product keeps rising at a slower rate; negative returns means marginal product has fallen below zero, so total product actually falls, e.g. from overcrowding on a fixed factor.
Exam-style questions
Written in the style of a A Level Economics exam paper, with a full mark scheme.
A bakery has a fixed number of ovens. Using the concept of the law of diminishing marginal returns, explain why adding more bakers to the fixed number of ovens will eventually reduce the marginal product of each extra baker.
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Evaluate the significance of the law of diminishing marginal returns for a firm's short-run production decisions.
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