When businesses and farms want to increase their output, they often increase their inputs, hiring additional workers or investing in new machinery. These marginal increases in inputs result in marginal product. However, another law of economics holds that more workers, machinery or other inputs will eventually result in diminishing marginal returns. Profit-maximizing firms must be aware of the point at which increasing inputs will maximize their marginal product.
Marginal product is the increase in total output produced by a company or farm that results from an additional unit of input, holding other inputs constant, according to economist Edwin Mansfield, author of "Microeconomics." For example, the marginal product of a farm that grows corn is the increase in corn yield that results from purchasing an additional unit of farming equipment, holding acreage and labor.
As firms increase the units of input in the production process, their overall output increases. However, the marginal product -- or additional output -- declines as the quantity of input increases. Applying the corn farm example, as a farm increases the number of workers, the additional wheat generated decreases. Economists call this decrease "diminishing marginal product." When the farm hires a few workers to harvest the corn, for example, they harvest from the best stalks in the field. As the farm hires more workers, the additional labor harvests corn from the same acreage. In short, as the farm hires more labor, each worker contributes less to the additional production of corn, meaning diminished marginal product.
Marginal product and diminishing returns represent important considerations for businesses and farms because they seek to maximize their profits. To earn the maximum amount of profit, a firm increases its input to the point where the value of the resulting marginal product equals the cost of the additional input, such as the wages paid to new workers, according to Harvard economist Gregory Mankiw.
It is important to remember that diminishing returns to marginal product do not apply to cases in which all inputs increase, but only those in which one input increases while holding others constant, according to Mansfield. For example, diminishing returns would not apply if a firm hires more workers while constructing a new production facility at the same time. In addition, the rule of diminishing returns to marginal product also assumes that technology remains fixed, because the rule cannot predict the impact of additional input if technology changes, as well.
- "Microeconomics"; Edwin Mansfield; 1996
- "Principles of Economics (3rd ed.)"; N. Gregory Mankiw; 2004
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