What are Diminishing Marginal Returns?

//What are Diminishing Marginal Returns?
What are Diminishing Marginal Returns? 2017-10-02T19:51:02+00:00

Definition: Diminishing marginal returns, also called the law of diminishing returns, is an economic concept that describes a situation where each additional input in the production process becomes less efficient than the last. In other words, as more and more resources are used, they become less efficient at producing products.

What Does Diminishing Marginal Returns Mean?

What is the definition of diminishing marginal returns? The law of diminishing returns is considered an inevitable factor of production. At some point the optimal amount of a certain input will be reached and after that point additional units will no longer be beneficial. Each additional resource will yield fewer and fewer benefits compared with the pervious resources.

At some point during the production process, adding an additional unit of input will do one of the following:

  1. Increase output at a direct rate
  2. Increase output at a decreased rate
  3. Not affect output
  4. Cause output to decrease

In order to optimize operations, management typically has to analyze each factor of production separately. This way they can see the point at which another input starts yielding fewer results than previous inputs. For example, management would look at labor and number of employees separate from additional plant sizes and capacity.

Management should analyze its production process periodically because there can come a time when additional units actually make the preceding units less effective.

Let’s look at an example.

Example

A typical example of this phenomenon is a company adding more workers to complete a job. Once enough workers are added, a point will come where adding more workers eventually causes issues or slows down the work each employee can perform.

Let’s assume a factory with 5 machines can facilitate 20 workers without any space constraints. The sudden increase in demand for their products has the management thinking that they need to hire more people. Currently, the factory has 15 workers including 10 assemblers and 5 machinists. Since the factory only has 5 machines, hiring more machinists won’t increase production unless another machine is purchased. Hiring additional product assemblers, on the other hand, will speed up the assembly. Here are the production rate increases of hiring four additional employees:

  1. 1 additional employee 20%
  2. 2 additional employee 30%
  3. 3 additional employee 35%
  4. 4 additional employee 37%

As you can see, each employee who is hired only increases production marginally. The first employee increases it the most and each increase process at half the rate. This is occurs because as more assemblers are added to the assembly process, the work is finished before the machinists are done with the parts, creating wait time.

Each factor of production operates best when they work in tandem. Thus in order to optimize the production process and avoid diminishing returns, management should purchase a new machine and hire two assemblers and one machinist.

Summary Definition

Define Diminishing Marginal Returns: The law of diminishing return means that for each additional input in the production process, fewer and fewer outputs are achieved.