Laws of Diminishing returns Numerical example

Factor Costs: Labour – wages/salaries Land – rent Capital – interest Enterprise - profit

Short and Long run: Short run – some factors fixed and cannot be increased/reduced Long Run – time taken to vary all factors of production Short and long run vary in all industries:

How can these ‘businesses’ increase productivity in the short run? Railways Supermarkets Local Builder

How can these ‘businesses’ increase productivity in the short run? Railways ‘easy’ to increase labour Supermarkets can buy new shelving, hire staff Local Builder new tools, hires assistant How can they increase production in the Long run? And how long is a long run?

How can they increase production in the Long run and how long is a long run? Railways long lead times for new rolling stock – 5 years Supermarkets Open new stores - takes several years Local Builder purchase a new van – takes a couple of months

Diminishing Marginal Returns Assumptions – some factors fixed (e.g. capital and land) Adding variable factor –labour Total Product Average Product = TP / Qv (variable factor) Marginal Product = ΔTP/ΔQv

Law of Diminishing Returns Capital Input Labour Input Total Output Marginal Product Average Product of Labour 20 1 5   2 16 3 30 4 56 85 6 114 7 140 8 160 9 171 10 180 11 187 More labour = more output… but when does ‘diminishing returns’ happen?

Total output – so where does diminishing returns set in? Can you see it yet??? So you need to calculate marginal product

Calculate Marginal Product… Capital Input Labour Input Total Output Marginal Product Average Product of Labour 20 1 5   2 16 11 3 30 4 56 85 6 114 7 140 8 160 9 171 10 180 187 To calculate MP At 2 workers…. 16-5 = 11 So you can calculate the rest!

Marginal product results… So where are the increasing returns? Optimal returns? and diminishing returns? Marginal product results… Capital Input Labour Input Total Output Marginal Product Average Product of Labour 20 1 5   2 16 11 3 30 14 4 56 26 85 28 6 114 29 7 140 8 160 9 171 10 180 187 At low levels of labour input, the fixed factors of production - land and capital, tend to be under-utilised which means that each additional worker will have plenty of capital to use and, as a result, marginal product may rise. Beyond a certain point however, the fixed factors of production become scarcer and new workers will not have as much capital to work with so that the capital input becomes diluted among a larger workforce. As a result, the marginal productivity of each worker tends to fall – this is known as the principle of diminishing returns.   

Average Product So now calculate the average product… total output / labour Capital Input Labour Input Total Output Marginal Product Average Product of Labour 20 1 5   2 16 11 8 3 30 14 4 56 26 85 28 6 114 29 7 140 160 9 171 10 180 187

So how many workers are productively efficient? Should the co employ 6 7 8 workers? So how many workers are productively efficient? Capital Input Labour Input Total Output Marginal Product Average Product of Labour 20 1 5   2 16 11 8 3 30 14 10 4 56 26 85 28 17 6 114 29 19 7 140 160 9 171 180 18 187 Using this logic – the co should only employ 6 workers. NO because the 7th, 8th etc worker still produces more on average – just that the returns are diminishing…. So how does a business decide how many workers to employ? Need to look at costs as well

Its easier to see on a graph…

Productive efficiency is at… 8 workers producing 160 units..

So now try an exercise yourself Don’t panic – this isn’t part of a DR or an essay…… However, it is the fundamental foundations of what you MUST KNOW for Marginal Costs, productive efficiency and economies of scale…i.e. unit 5!