diminishing marginal returns

Examples of diminishing marginal returns in the following topics:

• Marginal Product of Labor (Physical)

  • gives another example of marginal product of labor.
  • The law of diminishing marginal returns ensures that in most industries, the MPL will eventually be decreasing.
  • The law states that "as units of one input are added (with all other inputs held constant) a point will be reached where the resulting additions to output will begin to decrease; that is marginal product will decline. " The law of diminishing marginal returns applies regardless of whether the production function exhibits increasing, decreasing or constant returns to scale.
  • Under such circumstances diminishing marginal returns are inevitable at some level of production.
  • This table shows hypothetical returns and marginal product of labor.

• The Law of Diminishing Returns

  • The law of diminishing returns states that adding more of one factor of production will at some point yield lower per-unit returns.
  • In economics, diminishing returns (also called diminishing marginal returns) is the decrease in the marginal output of a production process as the amount of a single factor of production is increased, while the amounts of all other factors of production stay constant.
  • If the law of diminishing returns holds, however, the marginal cost curve will eventually slope upward and continue to rise, representing the higher and higher marginal costs associated with additional output.
  • However, as marginal costs increase due to the law of diminishing returns, the marginal cost of production will eventually be higher than the average total cost and the average cost will begin to increase.
  • Both marginal cost and average cost are U-shaped due to first increasing, and then diminishing, returns.

• Marginal Product of Labor (Revenue)

  • The marginal revenue product of labor is the change in revenue that results from employing an additional unit of labor.
  • The marginal revenue product of labor (MRPL) is the change in revenue that results from employing an additional unit of labor, holding all other inputs constant.
  • The marginal revenue product of a worker is equal to the product of the marginal product of labor (MPL) and the marginal revenue (MR) of output, given by MR×MP: = MRPL.
  • Assuming that the firm is operating with diminishing marginal returns then the addition of an extra worker reduces the average productivity of every other worker (and every other worker affects the marginal productivity of the additional worker) - in other words, everybody is getting in each other's way.
  • Define the marginal product of labor under the marginal revenue productivity theory of wages

• Optimal Quantity of a Public Good

  • The government is providing an efficient quantity of a public good when its marginal benefit equals its marginal cost.
  • Due to the law of diminishing marginal utility, the demand curve is downward sloping.
  • Because of the law of diminishing returns, the marginal cost increases as the quantity of the good produced increases.
  • Output activity should be increased as long as the marginal benefit exceeds the marginal cost.
  • An activity should not be pursued when the marginal benefit is less than the marginal cost.

• Defining the Production Function

  • This is also known as diminishing returns to scale - increasing the quantity of inputs creates a less-than-proportional increase in the quantity of output.
  • If it weren't for diminishing returns to scale, supply could expand without limits without increasing the price of a good.
  • Increasing marginal costs can be identified using the production function.
  • If a firm has a production function Q=F(K,L) (that is, the quantity of output (Q) is some function of capital (K) and labor (L)), then if 2Qmarginal costs and diminishing returns to scale.
  • Similarly, if 2Q>F(2K,2L), there are increasing returns to scale, and if 2Q=F(2K,2L), there are constant returns to scale.

• Principle of Diminishing Marginal Utility

  • The principle of diminishing marginal utility states that as more of a good or service is consumed, the marginal benefit of the next unit decreases.
  • The principle of diminishing marginal utility states that as an individual consumes more of a good, the marginal benefit of each additional unit of that good decreases.
  • The concept of diminishing marginal utility is easy to understand since there are numerous examples of it in everyday life.
  • This is a simple illustration of diminishing marginal utility .
  • So it is important to remember that "diminishing" does not necessarily mean to zero; you can have too much of a good thing.

• Return on Common Equity

  • ROE is the product of the net margin (profit margin), asset turnover, and financial leverage.
  • Also note that the product of net margin and asset turnover is return on assets, so ROE is ROA times financial leverage.
  • For example, if the net margin increases, every sale brings in more money, resulting in a higher overall ROE.
  • Financial leverage benefits diminish as the risk of defaulting on interest payments increases.
  • The return on equity is a ratio of net income to equity.

• Economies and Diseconomies of Scale

  • Increasing, constant, and diminishing returns to scale describe how quickly output rises as inputs increase.
  • There are three stages in the returns to scale: increasing returns to scale (IRS), constant returns to scale (CRS), and diminishing returns to scale (DRS).
  • Returns to scale vary between industries, but typically a firm will have increasing returns to scale at low levels of production, decreasing returns to scale at high levels of production, and constant returns to scale at some point in the middle .
  • The final stage, diminishing returns to scale (DRS) refers to production for which the average costs of output increase as the level of production increases.
  • Identify the three types of returns to scale and describe how they occur

• The Supply Curve in Perfect Competition

  • The total revenue-total cost perspective and the marginal revenue-marginal cost perspective are used to find profit maximizing quantities.
  • Profit maximization is the short run or long run process that a firm uses to determine the price and output level that returns the greatest profit when producing a good or service.
  • The marginal revenue-marginal cost perspective relies on the understanding that for each unit sold, the marginal profit equals the marginal revenue (MR) minus the marginal cost (MC).
  • If the marginal revenue is greater than the marginal cost, then the marginal profit is positive and a greater quantity of the good should be produced.
  • Likewise, if the marginal revenue is less than the marginal cost, the marginal profit is negative and a lesser quantity of the good should be produced .

• The Marginal Cost of Capital

  • The marginal cost of capital can also be discussed as the minimum acceptable rate of return or hurdle rate.
  • The investment in capital is logically only a good decision if the return on the capital is greater than its cost.
  • Also, a negative return is generally undesirable.
  • For this we must look into marginal returns of capital, which can be described as the gains or returns to be had by raising that last dollar of capital.
  • The Marginal Cost of Capital is the cost of the last dollar of capital raised.