Loading the player...

What is the 'Law Of Diminishing Marginal Productivity'

The law of diminishing marginal productivity is an economic principle that states that while increasing one input and keeping other inputs at the same level may initially increase output, further increases in that input will have a limited effect, and eventually no effect or a negative effect, on output. The law of diminishing marginal productivity helps explain why increasing production is not always the best way to increase profitability.

BREAKING DOWN 'Law Of Diminishing Marginal Productivity'

Marginal productivity refers to the extra output yielded by an additional unit of input. Inputs are most often labor, but they could also be components or raw materials. The law of diminishing marginal returns states that when a factor of production is fixed, there is a point at which an increasing volume of variable factors will become less productive. This means that each additional unit of input will produce less output than the prior unit of input. Diminishing marginal productivity results from rising short-term average costs. Firms can address issues related to rising short-term average costs by reducing output to an optimal level or increasing other factors of production. These measures can ensure profit maximization.

Diseconomies of Scale

Diminishing marginal returns should be distinguished from diseconomies of scale, which are the result of rising long-term average costs. These problems occur because a firm grows too large to continue operating efficiently, and administrative inefficiencies are usually at the core of this. Poor communication among departments, duplicative roles, lack of oversight over employee behavior, and bloated managerial structure all generate expenses that would not be incurred by smaller organizations. These do not necessarily indicate any problem with marginal profitability, because diseconomies of scale can be wholly unrelated to productive activities.


Consider a factory that produces a product called a widget. The factory uses the same amount of electricity to produce zero to 100 widgets, but the machinery functions less efficiently if it is overworked. The electricity consumed by the factory's machines increases exponentially from 101 widgets and higher. Marginal productivity rises as output approaches 100 widgets, because higher volumes can be produced and sold without incurring extra production expenses. However, after the 100-unit mark is breached, production costs start to rise more quickly than output volume. Eventually, the exponentially rising electricity costs will overtake the profits generated by each widget.

The company should explore other options, even if it must reduce its volume output. Alternatively, the company could purchase and deploy additional machinery, which would consume less electricity per unit.

  1. Efficiency Variance

    Efficiency variance is the difference between the theoretical ...
  2. External Diseconomies Of Scale

    External diseconomies of scale are the result of outside factors ...
  3. Diseconomies Of Scale

    An economic concept referring to a situation in which economies ...
  4. Efficiency

    A level of performance that describes a process that uses the ...
  5. Goal Seeking

    The process of finding the correct input when only the output ...
  6. Demand For Labor

    The demand for labor describes the amount and market wage rate ...
Related Articles
  1. Insights

    What Are Economies Of Scale?

    Is bigger always better? Read up on the important and often misunderstood concept of economies of scale.
  2. Investing

    Understanding Marginal Cost of Production

    Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit.
  3. Investing

    What's a Sensitivity Analysis?

    Sensitivity analysis is used in financial modeling to determine how one variable (the target variable) may be affected by changes in another variable (the input variable).
  4. Investing

    Bet Smarter With the Monte Carlo Simulation

    This technique can reduce uncertainty in estimating future outcomes.
  5. Personal Finance

    Supply Chain Management Jobs Are Booming

    There has been huge growth in supply chain management, both in the number of positions open and the range of responsibilities assigned to those positions.
  6. Investing

    Buying Stocks When the Price Goes Down: Big Mistake?

    Averaging down is a trumpeted strategy that has merit, but can amount to throwing money away when used carelessly.
  7. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
  8. Insights

    Explaining Minimum Efficient Scale

    Minimum efficient scale is the smallest amount of production a firm can achieve while still taking full advantage of economies of scale.
  1. What's the difference between diminishing marginal returns and returns to scale?

    Understand the main differences between the law of diminishing marginal returns and the concept of returns to scale through ... Read Answer >>
  2. How does the law of diminishing returns affect marginal revenue?

    Find out how the economic law of diminishing returns affects a business' marginal revenue, eventually reducing the effectiveness ... Read Answer >>
  3. How does a company make a spending decision using marginal analysis?

    Understand how a company uses marginal analysis in its spending decisions. Learn the benefits of marginal revenue and marginal ... Read Answer >>
  4. How is productivity calculated?

    Learn about productivity, what it measures and how to compute a company's productivity level by measuring its outputs relative ... Read Answer >>
  5. What is the difference between marginal benefit and marginal revenue?

    Understand the difference between marginal benefit and marginal revenue, and learn how each is maximized. Read Answer >>
  6. What is the difference between marginal benefit and marginal cost?

    Understand the difference between marginal benefit and marginal cost. Learn how and why both marginal cost and marginal benefit ... Read Answer >>
Hot Definitions
  1. Entrepreneur

    An Entrepreneur is an individual who founds and runs a small business and assumes all the risk and reward of the venture. ...
  2. Money Market

    The money market is a segment of the financial market in which financial instruments with high liquidity and very short maturities ...
  3. Perfect Competition

    Pure or perfect competition is a theoretical market structure in which a number of criteria such as perfect information and ...
  4. Compound Interest

    Compound Interest is interest calculated on the initial principal and also on the accumulated interest of previous periods ...
  5. Income Statement

    A financial statement that measures a company's financial performance over a specific accounting period. Financial performance ...
  6. Leverage Ratio

    A leverage ratio is any one of several financial measurements that look at how much capital comes in the form of debt, or ...
Trading Center