Question

Q2. What is the law of diminishing marginal productivity? How does the law of diminishing marginal productivity affect the cost of productions?

Provide an example from your workplace.

Answer 1

Ans) With increase in additional input, output increases. But after a certain point, with increase in additional input, the rate of increase of output starts declining. This is known as diminishing marginal product.

When there is no diminishing marginal product in the starting, increasing the input decreases the average cost because the cost is spread between more number of units. But as the diminishing marginal product sets in, average cost starts increasing because now the cost spreads between less number of units. (Average cost = total cost ÷ quantity).

For eg- suppose a bakery hires 2 workers and the output is 10 units of cake. When it hires 3rd worker, output is 18 units of cakes. When it hires 4th worker, output is 28 units of cake. But as soon as it hires 5th worker, output is 34 units of cakes. So we see that initially the output increased by 8, then by 10 and then on hiring 5th worker, it increased only by 6 units i.e on hiring 5th worker, diminishing marginal product sets in.

Now suppose the only cost of bakery is the wages given to workers, and let the wage of one worker be $10. When 2 workers are hired, average cost is $20÷10 = $2. When 3rd worker is hired, average cost is $30÷18 = $1.67. When 4th worker is hired, average cost is $40÷28 = $1.43. When 5th worker is hired, average cost is $50÷34 = $1.47. So we see that, on increasing 5th worker, average cost has started increasing.