Question

Please give a 300-400 word response

In the short run, neoclassical economics assumes diminishing marginal products. Explain what this means. What is the significance of this assumption (i.e. what does it do, what is its function in the analysis)? In the long run the assumption of diminishing marginal products does not hold. Why not? What assumption replaces diminishing marginal products? What do these assumptions indicate about the political aims of neoclassical economics?

Answer 1

1. The law of diminishing marginal returns is a theory in economics that predicts that after some optimal level of capacity is reached, adding an additional factor of production will actually result in smaller increases in output. For example, a factory employs workers to manufacture its products, and, at some point, the company operates at an optimal level. With other production factors constant, adding additional workers beyond this optimal level will result in less efficient operations.

The law of diminishing returns is related to the concept of diminishing marginal utility and can be contrasted with economies of scale.

• The law of diminishing marginal returns states that adding an additional factor of production results in smaller increases in output.
• After some optimal level of capacity utilization, the addition of any larger amounts of a factor of production will inevitably yields decreased per-unit incremental returns, the law says.
• Also known as the law of diminishing returns, this principle is closely related to the concepts of diminishing marginal productivity, and the law of variable proportions.

Understanding the Law of Diminishing Marginal Returns

The law of diminishing marginal returns is also known as the law of diminishing returns, the principle of diminishing marginal productivity, and the law of variable proportions. This law affirms that the addition of a larger amount of one factor of production, ceteris paribus, inevitably yields decreased per-unit incremental returns. The law does not imply that the additional unit decreases total production, which is known as negative returns; however, this is commonly the result.

The law of diminishing marginal returns does not imply that the additional unit decreases total production, but this is usually the result.

The law of diminishing returns is not only a fundamental principle of economics, but it also plays a starring role in production theory. Production theory is the study of the economic process of converting inputs into outputs.

History of The Law of Diminishing Returns

The idea of diminishing returns has ties to some of the world’s earliest economists including Jacques Turgot, Johann Heinrich von Thünen, Thomas Robert Malthus, David Ricardo, and James Steuart. The first recorded expression of diminishing returns came from Turgot in the mid-1700s. Classical economists, such as Ricardo and Malthus, attribute successive diminishment of output to a decrease in quality of input. Ricardo contributed to the development of the law, referring to it as the "intensive margin of cultivation."

He was the first to demonstrate how additional labor and capital added to a fixed piece of land would successively generate smaller output increases. Malthus introduced the idea during the construction of his population theory. This theory argues that population grows geometrically while food production increases arithmetically, resulting in a population outgrowing its food supply. Malthus’ ideas about limited food production stem from diminishing returns.

Neoclassical economists postulate that each “unit” of labor is exactly the same, and diminishing returns are caused by a disruption of the entire production process as extra units of labor are added to a set amount of capital.

Diminishing marginal returns are an effect of increasing input in the short run while at least one production variable is kept constant, such as labor or capital. Returns to scale, on the other hand, are an effect of increasing input in all variables of production in the long run.

Also known as economies of scale, let's look at a simple example. First imagine a manufacturer that is able to double its total input but gets only a 60 percent increase in total output; this is an example of decreasing returns to scale. Now, if the same manufacturer ends up doubling its total output, then it has achieved constant returns to scale, where the increase in output is proportional to the increase in production input. However, economies of scale, will occur when the percentage increase in output is higher than the percentage increase in input - so that by doubling inputs, output triples.

2. It was expressed by E. Roy Weintraub that neoclassical economics rests on three assumptions, although certain branches of neoclassical theory may have different approaches:

1. People have rational preferences between outcomes that can be identified and associated with values.
2. Individuals maximize utility and firms maximize profits.
3. People act independently on the basis of full and relevant information.

From these three assumptions, neoclassical economists have built a structure to understand the allocation of scarce resources among alternative ends—in fact understanding such allocation is often considered the definition of economics to neoclassical theorists. Here's how William Stanley Jevons presented "the problem of Economics".

Given, a certain population, with various needs and powers of production, in possession of certain lands and other sources of material: required, the mode of employing their labour which will maximize the utility of their produce.^[9]

From the basic assumptions of neoclassical economics comes a wide range of theories about various areas of economic activity. For example, profit maximization lies behind the neoclassical theory of the firm, while the derivation of demand curves leads to an understanding of consumer goods, and the supply curve allows an analysis of the factors of production. Utility maximization is the source for the neoclassical theory of consumption, the derivation of demand curves for consumer goods, and the derivation of labor supply curves and reservation demand.

Market supply and demand are aggregated across firms and individuals. Their interactions determine equilibrium output and price. The market supply and demand for each factor of production is derived analogously to those for market final output to determine equilibrium income and the income distribution. Factor demand incorporates the marginal-productivity relationship of that factor in the output market.

Neoclassical economics emphasizes equilibria, which are the solutions of agent maximization problems. Regularities in economies are explained by methodological individualism, the position that economic phenomena can be explained by aggregating over the behavior of agents. The emphasis is on microeconomics. Institutions, which might be considered as prior to and conditioning individual behavior, are de-emphasized. Economic subjectivism accompanies these emphases.

3. The “law of diminishing returns” is not really a law. In general, it exists as an assumption of diminishing returns to individual factors of production. What this means is that if the production of widgets is a function of two inputs, ‘L’ and ‘K’, doubling either L or K without changing the other will less than double the output of widgets. To understand why, let’s say that ‘L’ refers to labor (workers) and ‘K’ refers factory space. Increasing the number of workers without increasing the size of the factory will result in crowded workers who are less effective. Increasing the factory space without increasing the number of workers will result in a lot of wasted space.

All of these assumptions hold in the long run. What is different is that in the long run, it is assumed that all factors of production are variable. That is, both L and K can be doubled to maximize production, rather than having to increase one while the other stays fixed. This can produce diminishing, constant, or increasing returns to scale, depending on the market. But there is no reason to assume diminishing returns. This can produce diminishing, constant, or increasing returns to scale, depending on the market. But there is no reason to assume diminishing returns. ... If the law of diminishing marginal product did not hold, the world's food supply could be grown in a flowerpot.

4. The main assumptions of the law are:

a. No Change in Technology:

First of all, the law is based on the assumption that there is no change in the techniques of production. If the techniques of production undergo a change, in that case the efficiency of production would increase. Therefore, this law applies only if there is no change in the method of technology.

b. Short Period:

The law is applicable in the short run as supply of one or the other factor cannot be increased within the short span of time. Thus, they are considered fixed.

c. Homogeneous Units:

All units of variable factors of production are assumed to be homogeneous.

d. Measurement of Product.

The output is measured in physical units like tones, kilograms etc.

5. The essence of a notion of diminishing marginal utility can be found in Aristotle's Politics, wherein he writes

external goods have a limit, like any other instrument, and all things useful are of such a nature that where there is too much of them they must either do harm, or at any rate be of no use.

There has been marked disagreement about the development and role of marginal considerations in Aristotle's' value theory.

A great variety of economists concluded that there was some sort of inter-relationship between utility and rarity that effected economic decisions, and in turn informed the determination of prices.

Marginal utilities were the ultimate determinant of demand, yet apparently did not pursue implications, though some interpret his work as indeed doing just that.