Marginal productivity theory The demand for labour Marginal productivity theory

Production in the short run The short run is defined as the period of time during which all fixed factors and the scale of production remain unchanged. In the short run a firm will look to increase output by more workers to the production process (increasing its variable factors) Where an extra worker adds more to total output than the previous worker, the firm is said to be experiencing increasing marginal returns to scale. Where an extra worker adds less to total output than the previous worker, the firm is said to be experiencing diminishing marginal returns to scale. A firm will continue to add workers to the production process until the average product falls

How levels of output change in the short run as more workers are employed. No. of workers Total Product Average product Marginal product 3 1 4 2 7 3.5 9 16 5.3 12 28 17 5 45 15 6 60 10 63

Total, average and marginal product

Optimum output Firms will continue to increase output until the marginal product of successive workers is greater than the previous worker. A fall in the ‘nth’ worker’s marginal product is not the signal to stop employing another worker as the average product may still rise. Optimum output comes when the average product is at its highest. This is also known as productive efficiency as the firm is operating at the minimum average cost.

Production in the long run In the long run a firm can temporarily overcome the problem of diminishing marginal returns as it can change its fixed factors. More capital intensive production methods and/or larger premises are such examples. As the firm continues to add variable factors (more workers) to this new mix it will again enjoy increasing returns to scale. The problem of diminishing marginal returns re-emerges as the fixed factors become overloaded. The firm now has the option of varying its fixed factors to find a new mix of fixed and variable factors that reduces the cost of production, or accept that higher levels of output with its current mix is takes it past the optimum.