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Economics Part A

Table of Contents

Diminishing Marginal Returns Explained

Diminishing Marginal Returns, also known as diminishing returns, is a phenomenon found primarily in factories and farms. It occurs when the addition of workers into a given industrial setting causes each additional worker to contribute less to the total output. In the most extreme cases, additional employees could result in damage since physical crowding prevents the factory or farm workers from functioning properly. Unskilled workers without supervision also can cause economic and financial harm to the firm. It must be emphasized that the idea of diminishing returns relates to a static situation within a given industrial setting during which the factory’s physical size remains the same, no additional production equipment has been purchased, and employees have not received additional training.

The following example illustrates the concept of diminishing returns: In Country A, a furniture firm employs 10 carpenters. The firm is the only furniture company in the country. The remainder of the population is employed in other sectors. Each carpenter operates a machine that produces ten chairs every day. The entire factory thus produces 100 chairs each day. The firm receives an unusually large order for chairs, and the employees must quickly prepare in order to supply the requested merchandise.

Stage 1: The factory asks its carpenters to each work an extra shift. Since they are tired after a full day’s work, the carpenters’ output during the extra shift is lower than usual. While working overtime, a carpenter produces only eight chairs, instead of the usual 10. This proves insufficient to meet the order, so the company recruits five additional unskilled workers from other sectors of the economy.

The new employees are not trained as carpenters, nor does the factory have appropriate equipment for them to use. Instead, they assist the existing carpenters by bringing them chair parts, connecting the parts, inspecting finished chairs, and hauling off the finished chairs for packaging and shipping. Their additional contribution to the factory’s output, however, is low. With their help, the firm produces an extra twenty chairs per day, or equivalent to an additional four chairs per new worker per day.

If the company decides to add even more new employees, then crowding and mayhem on the factory floor will potentially increase. Due to their lack of training, the new workers may assemble the chairs in the wrong way, thereby causing delays in the workflow. It is quite likely that the additional contribution of each new employee would amount to only two chairs per day, so the contribution of each new worker to the firm’s total output would be even smaller. This is the meaning of declining marginal output, i.e. diminishing returns.

More Details about Diminishing Returns 

The occurrence of Diminishing Marginal Returns is not solely linked to the addition of more employees. Adding more machinery or structures can also cause diminishing returns.

All of these categories (human resources, machinery, and buildings) are called the means of production. This concept will be discussed in more depth at a later date. The effects of declining marginal output can be observed when the amount of one of the means of production is increased, and the others are left unchanged.

Dont Be Confused by Marginal

The word marginal, which is derived from the word margin, does not mean something unimportant, or of low quality. In economic terms, the term marginal refers to the additional contribution to total output gained from the deployment of an additional unit of the means of production. For example, the marginal output of a new worker reflects the amount (or value) of output that the specific new employee brings to the firm. The same applies to an extra machine, or to one additional hour of labor, in relation to the added contribution of a new tool or of working overtime. The marginal output for human resources represents the value in money or units by adding one additional employee to a factory.