The law of diminishing returns in the short run

Businesses can boost their output by using more factors of production, such as labour, capital, or raw materials. In the long run, all these factors can be adjusted, but in the short run, some factors remain fixed while others can vary. The law of diminishing returns focuses on what occurs when a variable factor is increased while fixed factors stay the same. This principle only applies in the short run.

Statement of the law of diminishing returns

The law of diminishing returns states that if a variable factor of production is increased while other factors remain fixed, eventually the marginal returns from the variable factor will start to decrease. This is also known as the law of diminishing marginal returns or the law of variable proportions.

How diminishing returns occur

• Initial increase in marginal product - At first, adding more units of a variable factor, such as labour, can lead to higher marginal product because it allows for greater specialisation.
• Eventual decrease in marginal product - As more of the variable factor is added, fixed factors like machinery or space begin to limit the extra output, and the marginal product will begin to fall. For instance, in a bakery with only five ovens, a sixth baker would add less output than the fifth, and a seventh even less.
• Potential fall in total output - If the variable factor continues to increase excessively, total output might even decline, such as when too many workers on an assembly line start hindering each other.

Marginal, average, and total product

Total product

Total product (TP) is the overall output generated from a specific mix of factor inputs.

Marginal product

Marginal product (MP) is the extra output created by adding one more unit of a variable factor input, also called marginal returns.

Average product

Average product (AP) is the output per unit of the variable factor input, calculated as total product divided by the number of units of input. This is often referred to as productivity, such as labour productivity measured as output per worker or per hour worked.

Relationship between marginal and average product

As more of a variable factor is added:

• Marginal product initially rises but eventually falls due to diminishing returns.
• Average product increases at first and reaches a maximum where it intersects with the marginal product curve.
• After this point, average product begins to decline as marginal product continues to fall.
• If a business keeps hiring more staff, for example, the average output per employee will eventually drop because fixed resources become overstretched.

The relationship between marginal product and marginal cost

Marginal product directly influences the costs of production, particularly marginal cost, which is the extra cost of producing one more unit of output.

How marginal product affects marginal cost

• When marginal product is increasing, marginal cost decreases because each additional unit of input produces more output, spreading costs more efficiently.
• When marginal product starts to decrease (diminishing returns), marginal cost begins to rise since less output is gained from each extra unit of input, making each unit more expensive to produce.
• The marginal cost curve acts as a mirror image of the marginal product curve: as one rises, the other falls, and vice versa.

This relationship shows that diminishing returns lead to higher costs per unit, which can impact a business's pricing and profitability decisions.

Factors that improve productivity

Productivity, or average product, measures how efficiently inputs are turned into outputs. Enhancing it allows businesses to produce more with the same resources, which can lower production costs and improve competitiveness.

Ways to increase productivity

• Enhanced training - Providing workers with better skills development can make them more efficient and reduce errors.
• Improved management - Effective leadership and organisation can streamline processes and motivate staff to perform better.
• Advanced technology - Investing in better equipment or tools enables workers to produce more output in less time, such as using automated machinery in manufacturing.