Law of diminishing marginal productivity: Meaning, Criticisms & Real-World Uses

What Is the Law of Diminishing Marginal Productivity?

The Law of Diminishing Marginal Productivity, also known as the law of diminishing returns, is a fundamental economic principle asserting that as one input to a production function is increased, while all other factors of production are held constant, the marginal output gained from each additional unit of the variable input will eventually decrease. This concept falls under the broader category of microeconomics and is crucial for understanding efficiency in production. It highlights that simply adding more of one resource does not guarantee a proportional increase in output indefinitely; at some point, the benefits of each additional unit of input will start to decline, even if the total output continues to rise.

History and Origin

The concept of diminishing returns can be traced back to the concerns of early economists in the 18th and 19th centuries, particularly in the context of agriculture. French economist Anne Robert Jacques Turgot is credited with first articulating the principle in the mid-1700s, observing that successive increases in an input would become "less and less productive." Later, classical economists such as David Ricardo, Thomas Robert Malthus, and James Anderson further developed the idea. Ricardo, for instance, applied the concept to land cultivation, noting that adding more labor and capital to a fixed piece of land would eventually yield successively smaller increases in output.⁷ Malthus incorporated a variation of the law into his population theory, suggesting that food production would increase arithmetically while populations grew geometrically, leading to a point where population outgrows its food supply due to diminishing returns on agricultural land. These early economists often attributed the diminishment of output to a decrease in the quality of input.⁶ However, neoclassical economists later posited that the law applies even with identical units of input, as the disruption of the entire production process can lead to diminishing returns when a single factor is increased while others remain fixed.

Key Takeaways

The Law of Diminishing Marginal Productivity states that increasing one input while keeping others constant eventually leads to smaller additional units of output.
This principle operates in the short run when at least one factor of production is fixed.
It highlights that efficiency and labor productivity will decrease beyond an optimal point of input.
The law does not imply a decrease in total output, but rather a decrease in the rate of increase of total output.
Understanding this law is crucial for optimal resource allocation in any production process.

Formula and Calculation

While the Law of Diminishing Marginal Productivity doesn't have a single formula to "calculate" the law itself, it is demonstrated by observing changes in total product, marginal product, and average product as a variable input is increased.

Total Product (TP): The total quantity of output produced by a given quantity of inputs.
Marginal Product (MP): The additional output produced by adding one more unit of a variable input, while holding all other inputs constant. It is calculated as: $MP = \frac{\Delta TP}{\Delta Variable Input}$ where (\Delta TP) is the change in total product and (\Delta Variable Input) is the change in the variable input.
Average Product (AP): The total product divided by the total quantity of the variable input used. It is calculated as: $AP = \frac{TP}{Variable Input}$

The law manifests when the marginal product begins to decline. Initially, as more variable input is added, marginal product may increase due to specialization or better utilization of fixed resources (increasing returns). However, after a certain point, adding more units of the variable input will result in progressively smaller increases in total output, meaning the marginal product starts to diminish. Eventually, marginal product could even become negative, leading to a decrease in total product.

Interpreting the Law of Diminishing Marginal Productivity

Interpreting the Law of Diminishing Marginal Productivity involves recognizing the point at which adding more of a single input no longer yields proportionate returns. This law operates under the assumption of ceteris paribus, meaning all other factors of production remain constant. When a business, for instance, continuously adds workers (a variable input) to a fixed amount of machinery or workspace (fixed inputs), there will be an initial phase where output increases rapidly due to increased specialization and efficiency. However, beyond a certain point, the additional workers may start to get in each other's way, share equipment, or face limited space, leading to a decline in the additional output each new worker contributes. This decrease in marginal product signals the onset of diminishing returns. Understanding this inflection point is critical for optimizing production and maintaining efficiency in operations.

Hypothetical Example

Consider a small bakery that specializes in artisanal bread. The bakery has a fixed amount of oven space, mixing equipment, and counter space. Initially, the owner works alone and produces 20 loaves per day.

Scenario 1: Adding a second baker. With two bakers, they can specialize tasks (one mixes, one shapes, both bake), leading to a significant increase in total output. They produce 50 loaves per day. The marginal product of the second baker is 30 loaves (50 - 20). This represents increasing returns.
Scenario 2: Adding a third baker. A third baker joins. They can further refine the process, maybe focusing on specific types of bread or managing quality control. Total output rises to 75 loaves per day. The marginal product of the third baker is 25 loaves (75 - 50). While total output increased, the marginal gain (25) is less than that of the second baker (30), indicating the onset of diminishing marginal productivity.
Scenario 3: Adding a fourth baker. A fourth baker is hired. Now, the bakery starts to feel crowded. They might have to wait for oven space, or share mixing bowls. Total output only increases to 90 loaves per day. The marginal product of the fourth baker is 15 loaves (90 - 75). The marginal return continues to diminish, highlighting the constraint of fixed capital expenditure (the bakery size and equipment).

This example illustrates how, even with capable individuals, the fixed nature of other inputs eventually limits the additional output each new unit of the variable input can generate.

Practical Applications

The Law of Diminishing Marginal Productivity has widespread practical applications across various economic sectors:

Agriculture: This is where the law was first observed and remains highly relevant. As more fertilizer or labor is applied to a fixed plot of land, yields will increase up to a point, but eventually, the additional output from each extra unit of input will decline. For instance, while modern agricultural technologies have significantly increased crop yields, there are concerns about the sustainability of intense input use due to diminishing returns and environmental impacts, such as groundwater depletion and increased soil toxicity from overuse of fertilizers and pesticides.⁵ ⁴
Manufacturing: In a factory, adding more workers to a fixed number of machines or limited workspace will eventually lead to lower per-worker productivity. Initially, output may increase, but congestion, shared resources, and coordination challenges will cause the marginal product of additional labor to decline.
Technology and Software Development: Beyond a certain point, adding more developers to a software project may not accelerate completion proportionally, often due to increased communication overhead, coordination difficulties, and integration challenges.
Marketing and Advertising: Increasing advertising spend beyond a certain threshold can lead to diminishing returns, where each additional dollar spent generates fewer new customers or sales. There's a point where the market is saturated or the message loses its impact.
Human Resources and Training: While initial training can significantly boost employee performance, endless additional training for a specific task might offer progressively smaller improvements in output or skill.

Understanding this law helps businesses make informed decisions about scaling operations, investing in new capital, and optimizing their workforce to avoid inefficiencies and maximize production.³

Limitations and Criticisms

While the Law of Diminishing Marginal Productivity is a robust principle, it comes with certain limitations and criticisms:

Ceteris Paribus Assumption: The law strictly applies only when all other factors of production are held constant. In reality, businesses often adjust multiple inputs simultaneously or introduce technological advancements, which can temporarily offset or delay the onset of diminishing returns. For example, improvements in agricultural technology, such as new crop varieties or irrigation systems, can significantly increase yields even with existing land, effectively shifting the production function.²
Short-Run Phenomenon: The law primarily operates in the short run, where at least one factor of production is fixed. In the long run, all factors of production are variable, and a company can scale up all inputs proportionally. This leads to considerations of returns to scale rather than just diminishing marginal productivity.
Technological Advancement: Technological innovation can fundamentally alter production processes, making them more efficient and pushing back the point at which diminishing returns set in. New machinery, automation, or improved processes can allow more output to be generated with the same or even fewer inputs. For instance, economists initially feared that population growth would inevitably lead to widespread poverty due to diminishing returns in agriculture, but technological advances have allowed many economies to continuously increase productive outputs despite rising populations.¹
Measurement Challenges: Accurately measuring marginal product can be challenging in complex production environments where outputs are not easily quantifiable or when multiple inputs contribute to a single output in intricate ways.

Despite these limitations, the Law of Diminishing Marginal Productivity remains a critical concept in economic growth analysis and helps explain why unchecked growth in a single input is not a sustainable path to endless productivity gains.

Law of Diminishing Marginal Productivity vs. Returns to Scale

The Law of Diminishing Marginal Productivity is often confused with returns to scale, but they describe different phenomena related to production in distinct time horizons.

The Law of Diminishing Marginal Productivity operates in the short run, focusing on how output changes when only one factor of production is increased, while at least one other factor remains fixed. It explains that beyond a certain point, the additional output from each extra unit of the variable input will decrease. This concept highlights the challenges of trying to increase production by simply adding more of a single input to a fixed capacity.

In contrast, Returns to Scale describes what happens to output when all factors of production are increased proportionally in the long run. There are three possibilities:

Increasing Returns to Scale (economies of scale): Output increases by a larger proportion than the increase in inputs.
Constant Returns to Scale: Output increases by the same proportion as the increase in inputs.
Decreasing Returns to Scale (diseconomies of scale): Output increases by a smaller proportion than the increase in inputs.

The key distinction lies in the variability of inputs: one variable input with fixed inputs for diminishing marginal productivity (short run), versus all inputs being variable for returns to scale (long run).

FAQs

What does "marginal" mean in this context?

"Marginal" in economics refers to the additional, incremental, or extra unit of something. So, marginal product is the additional output gained from adding one more unit of an input.

Does the law of diminishing marginal productivity mean total output will decrease?

Not necessarily. The law states that the rate of increase in total output will decline, meaning total output still increases, but at a slower pace. Eventually, if too much of the variable input is added, total output could indeed decrease, entering a stage of negative marginal returns.

Why is this law important for businesses?

Understanding the Law of Diminishing Marginal Productivity helps businesses make optimal decisions regarding investment and staffing. It guides them in determining the most efficient allocation of resources to avoid over-investing in one input when others are fixed, thereby maximizing profitability and overall efficiency.

Is the law of diminishing returns only applicable to physical production?

No, while often illustrated with physical production like agriculture or manufacturing, the principle applies broadly to any process where adding more of one input to a fixed set of other inputs can lead to diminishing incremental benefits. This can include service industries, marketing campaigns, or even studying for an exam.

How does technology affect the law of diminishing marginal productivity?

Technological advancements can significantly alter the point at which the law of diminishing marginal productivity sets in. New technologies can make existing inputs more productive or allow for more efficient use of resources, effectively pushing out the threshold where diminishing returns begin. However, the law still holds for a given state of technology; without further technological progress, adding more of a single input will eventually lead to diminishing marginal returns.