As production capacity increases, the return gained per each new unit of capacity decreases after a certain point. This is the law of diminishing marginal returns. In the short run, increasing production capacity may be a prohibitive cost for businesses and may prevent further expansion completely. This is highly dependent on the law of supply and demand, as increasing consumer spending demand may drive up prices enough to justify production improvements that were previously too expensive.
Marginal returns may be calculated using Excel to help determine if additional production would result in prohibitive expense.
- According to economic theory, a business should continue operating so long as its marginal return (marginal product) exceeds its marginal cost.
- While a relatively simple calculation, when using a large amount of data, a software package like Excel can make it easier and quicker to compute.
- Here, we show how to calculate marginal return in Excel, beginning with unit production cost.
Calculating Diminishing Marginal Returns in Excel
To calculate the diminishing marginal return of product production, obtain values for the production cost per unit of production. A unit of production may be an hour of employee labor, the cost of a new workstation or another value. Different businesses and different industries may have unique costs and production needs.
- After determining which production cost value to use, create an Excel spreadsheet column titled "Total Production."
- Place the values in the next column, giving the top row a title based on the type of production cost unit used, such as "Dollars per Hour," with a new row for each value.
- In the "Production Cost" column, put a value in each row indicating how many of each product is now produced or choose another value for each row showing the production capacity gained by adding each unit.
For example, perhaps hiring the first employee costs $15 per hour of production and creates 20 products per hour. In this case, the first column should have a row with the values 20 and 15. Entering another set of values such as $15 an hour and 30 provides an opportunity to calculate the return and see if the margin is changing.
For these first two employees, the margin remained the same with each producing 15 products for a total of 30. The third employee, however, costs $15 per hour, but the total production only increased by 12, to a total of 42. The returns are now diminishing, as the production per employee fell from 15 products per hour to only 12 products per hour.