Definition: The Law of Diminishing Marginal Product is the economic concept shows increasing one production variable while keeping everything else the same will initially increase overall production but will generate less returns the more that variable is increased. In other words, increasing one factor of production while keeping everything else the same will not be productive past a certain point.
What Does Law of Diminishing Marginal Product Mean?
This affects all businesses that use inputs to create an output: think software, manufacturing, and service companies. This phenomenon means that a company cannot just use the maximum labor or machinery that it can afford, because that will not be efficient. In order to be as cost-efficient as possible, a producer needs to know when DMP starts to affect their business.
Let’s look at an example.
Example
Alice is the COO of a large manufacturing company that creates bottles using only machinery. Her company is creating a new plant, and Alice has to decide the ideal number of machines for their production goals. She keeps a detailed record of which machines she will buy, and how they affect production. However, one day she notices something weird: production has actually been going down while she’s added machinery. How could this be?
She looks through her record, and sees the following: the first machine added 20 bottles, the second machine added 13 bottles, and the third machine added 6 bottles, for a total production of 39 bottles. However, when the fourth and fifth machines were added, total production dropped to 38 bottles, and then 31 bottles. She looks out to the factory floor, and sees that some machines are not using any materials, and are idle because there are too few people to service all of the machines.
This decrease in production from each additional or “marginal” machine shows that there is an optimal number of machines in the production process. If there are too few machines, things will run slowly. If there are too many machines, the factory will run out of space or time to service them and production will run equally as slowly. Instead of filling the new plant with extra machines, Alice should look into hiring more workers or building a bigger facility to increase production.
