The Law of Diminishing Returns

A diminishing marginal product of labor (and a diminishing marginal product of other inputs) holds for most production processes; the phrase "the law of diminishing returns" is often used to describe this phenomenon. The law of diminishing returns states that as the use of an input increases (with other inputs fixed), a point will eventually be reached at which the resulting additions to output decrease. When the labor input is small (and capital is fixed), small increments in labor input add substantially to output as workers are allowed to develop specialized tasks. Eventually, however, the law of diminishing returns applies. WTien there are too many workers, some workers become ineffective, and the marginal product of labor falls.

The law of diminishing returns usually applies to the short run where at least one input is fixed. However, it can also apply to the long run. Even though all inputs are variable in the long run, a manager may still want to analyze production choices for which one or more inputs are unchanged. Suppose, for example, that only two plant sizes are feasible, and a manager must decide which to build. TTien, the manager would want to know when diminishing returns will set in for each of the two options.

Do not confuse the law of diminishing returns with possible changes in the quality of labor as labor inputs are increased (as, for example, if the most highly qualified laborers are hired first, and the least qualified last). In our analysis of production, we have assumed that all labor inputs are of equal quality; diminishing returns result from limitations on the use of other fixed inputs (e.g., machinery), not from declines in worker quality. Also, do not confuse diminishing returns with negative returns. The law of diminishing returns describes a declining marginal product, but not necessarily a negative one.

The law of diminishing returns applies to a given production technology. Over time, however, inventions and other improvements in technology may allow the entire total product curve in Figure 6.2a to shift upward, so that more output can be produced with the same inputs. Figure 6.3 illustrates this.

Marginal Product Curve

FIGURE 6.3 The Effect of Technological Improvement. Labor productivity (output per unit of labor) can increase if there are improvements in the technology, even though any given production process exhibits diminishing returns to labor. As we move from point A on curve Oi to B on curve Oi to C on curve (9 > over time,labor productivity increases.

Initially the output curve is given by 0\, but improvements in technology may allow the curve to shift upward, first to O2 and later to O3.

Suppose that over time as labor is increased in production, technological improvements are also being made. Then, output changes from A (with an input of 6 on curve Oi) to B (with an input of 7 on curve O2) to C (with an input of 8 on curve O3). The move from A to B to C relates an increase in labor input to an increase in output and makes it appear that there are no diminishing returns when there are. For inputs greater than 6, each of the individual product curves exhibits diminishing returns to labor.

The shifting of the total product curve hides the presence of diminishing returns, and suggests that they need not have any negative long-run implications for economic growth. In fact, as we discuss in Example 6.1, the failure to account for improvements in technology in the long ran led British economist Thomas Malthus wrongly to predict dire consequences from continued population growth.

^^f/Si^ALTiiUS AND'THE"FOOP CRISIS £

The law of diminishing returns was central to the thinking of economist Thomas Malthus (1766-1834).1 Malthus believed that the limited amount of land on our globe would not be able to supply enough food as population grew and more laborers began to farm the land. Eventually as both the marginal and average productivity of labor fell and there were more mouths to feed, mass hunger and starvation would result. Fortunately, Malthus was wrong (although he was right about the diminishing returns to labor).

table 6.3 Iridjex'of World Food Consumption Pdr Capita

Year

Index

1948-1952

100

1955

109

1960

115

1965

116

1970

123

1978

128

1987

133

1991

142

Thomas Malthus, Essay on the Principle of Population, 1798. 2 All but the data for 1987 and 1991 appear as Table 4-1 in Julian Simon, The Ultimate Resource (Princeton: Princeton University Press, 1981). The original source for all the data is the UN Food and Agriculture Organization, Production Yearbook, and World Agricultural Situation.

Thomas Malthus, Essay on the Principle of Population, 1798. 2 All but the data for 1987 and 1991 appear as Table 4-1 in Julian Simon, The Ultimate Resource (Princeton: Princeton University Press, 1981). The original source for all the data is the UN Food and Agriculture Organization, Production Yearbook, and World Agricultural Situation.

Over the past century, technological improvements have dramatically altered the production of food in most countries (including developing countries, such as India), so th at the average product of labor has increased. These improvements include new high-yielding and disease-resistant strains of seeds, better fertilizers, and better harvesting equipment. As Table 6.3 shows, overall food production throughout the world has outpaced population growth more or less continually sincc the end of World War II.

Some of the increase in food production has been due to small increases in the amount of land devoted to farming. For example, from 1961 to 1975, the percentage of land devoted to agriculture increased from 32.9 percent to 33.3 percent in Africa, from 19.6 percent to 22.4 percent in Latin America, and from 21.9 percent to 22.6 percent in the Far East.3 However, during the same perioa. the percentage of land devoted to agriculture fell from 26.1 percent to 25.5 percent in North America, and from 46.3 percent to 43.7 percent in Western Europe. Clearly most of the improvement in food output is due to improved technology and not to increases in land used for agriculture.

Hunger remains a severe problem in some areas, such as the Sahcl region of Africa, in pari because of the low productivity of labor there. Although other countries produce an agricultural surplus, mass hunger still occurs bccausc of the difficulty of redistributing foods from more to less productive regions of the world, and because of the low incomes of those less productive regions.

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