Consider a firm that produce wheat with land and labor inputs discuss and contrast diminishing returns and dec
When one of the factors of production is held fixed in supply, successive additions of the other factors will lead to an increase in returns up to a point, but beyond this point returns will diminish.
This famous law was first written about by a Frenchman, Anne Robert Jacques Turgot and then alluded to by Thomas Malthus in his Essay on the Principle of Population (1798). The law was discussed in England during debates on free trade and the Corn Laws. Sometimes textbooks call it the law of decreasing (marginal) returns or the law of variable proportions.
Imagine a farm growing wheat. There are a number of jobs that need doing at harvest time and these must be done quickly before weather ruins the crop. First the wheat must be cut and gathered, the wheat and chaff must then be separated. The wheat has then to be carted to a barn, weighed, dried out in some instances, and then stored. All the farm machinery needs maintained, the paperwork completed and last but not least breakfast, lunch and dinner prepared. One man working alone will have difficulty doing all these tasks. By dividing the labour there will be gains in productivity (see division of labour).
If a second worker is employed the tasks can be shared. This means that productivity increases. They each become more skilled in the tasks that they specialise in and save time previously wasted by switching between tasks. However both have to stop when a piece of machinery breaks down or one of them stops for lunch. Employing yet another person may once again improve their productivity. The harvest may continue as they take their lunch in rotation for example. But employing a fourth worker might mean productivity begins to fall (diminish). The gains made by employing the 4th are not as great as employing the 3rd worker. Eventually adding more employees might even lead to an overall decrease in production as they become bored with nothing to do and begin to interfere with production. The table below shows what happens as each extra worker is employed. Marginal means the next unit. So the marginal physical product (MPP) is the amount by which production rises when one extra worker is employed. MPP is calculated by measuring the change in total physical production per worker. The average physical product (APP) is simply the total physical product (TPP) divided by the number of workers
Number of workers /Total Physical Product (TPP)/ Marginal Physical Product (MPP)/ Average Physical Product (APP)
1 / 10/10/10
2/ 30/ 30 -10 = 20/ 15
3/ 90/ 90 - 30 = 60/ 30
4/ 120/ 120 -90= 30/ 30
5/ 130/ 130 -120 = 10/ 26
6/ 120/ 120 -130 = -10/ 20 In the example the factors of production land and capital are constant but the amount of labour is being varied. The marginal physical product, (MPP) increases to start. When the 4th worker is employed the total still increases from 90 to 120 tonnes, but the increase of 30 tonnes is not as great as the previous increase of 60. It as this point that we say the marginal return diminishes.When MPP becomes negative this means that additional workers are causing a reduction in the total production and the TPP curve changes direction downwards.
The relationship between the marginal and average curves is important to understand. Notice that MPP intersects the APP when APP is at its maximum point. The reason is merely a simple mathematical relationship between marginal and averages. Think of a class of students. The average age in the class is 17. If another student comes in the room and they are 18, what will happen to the average? – It will of course increase. On the other hand if the student were 16 the average age in the class would fall. So in the graph, as long as the marginal is higher than the average the average curve goes up and when the marginal is below the average. The average falls.
The demonstration of the law above rests on a couple of assumptions. First we assume that each unit of labour is homogenous. That is that each worker has the same skills and works equally hard. Second, all the other factors of production are held fixed in quantity.
The law of diminishing marginal returns has two main applications for IB students.
1. The shape of the short run cost curve is determined by the principles above and,
2. Diminishing marginal returns in agriculture act as a barrier to economic development
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