Y2 1) Law of Diminishing Returns

Summary

This video script delves into the law of diminishing marginal returns, a key economic concept that impacts businesses in the short run, where at least one factor of production is fixed. It uses the example of a pizza-making business to illustrate how increasing labor can initially boost output but eventually leads to a decline due to overburdening fixed resources like ovens and workspace. The script explains the relationship between labor and output through the concepts of total product, marginal product, and average product, highlighting the transition from increasing to decreasing productivity as workers are added beyond a certain point.

Takeaways

• 📉 The law of diminishing marginal returns affects businesses in the short run, when at least one factor of production is fixed.
• 🏗️ In the short run, businesses can only increase output by adding labor, with land and capital often being fixed.
• 🔢 Marginal product is the additional output gained from adding one more worker and can initially rise before falling due to diminishing returns.
• 🍕 The example used is a pizza-making business with a fixed number of ovens and workspace, and increasing labor leads to different levels of productivity.
• 📈 At first, marginal product and average product rise as workers specialize and make better use of underutilized fixed resources.
• ⏬ After reaching a certain point, adding more workers leads to a decrease in marginal product as workers get in each other's way.
• ⚖️ The marginal product curve rises initially, then falls, while the average product curve follows a similar pattern, but less steeply.
• 🔄 The marginal product curve must cut the average product curve at its highest point, representing the maximum productivity before diminishing returns set in.
• ⏹️ Total product (TP) continues to increase but at a slower rate, and it peaks when the marginal product is zero.
• 🛠️ The law of diminishing returns helps explain the shape of many cost curves in the short run, which are crucial for business decision-making.

Q & A

What is the law of diminishing marginal returns?

The law of diminishing marginal returns states that in the short-run, when variable factors of production (like labor) are added to a fixed stock of factors (like land and capital), the total or marginal product will initially rise and then fall.

What is the definition of the short-run in the context of the script?

In the context of the script, the short-run is a period of time where there is at least one fixed factor of production, typically capital and land, which cannot be changed.

Why is labor considered the variable factor of production in the short-run?

Labor is considered the variable factor of production in the short-run because it is the only factor that can be easily increased or decreased to alter output, while capital and land remain fixed.

How does the law of diminishing returns affect a business's output when more workers are hired?

According to the law of diminishing returns, as more workers are hired in the short-run, the marginal product initially increases but eventually starts to decrease due to the fixed factors of production becoming a constraint.

What is meant by 'marginal product' in the context of the script?

Marginal product refers to the additional output produced by employing one more worker. It is calculated as the change in total product divided by the change in the quantity of workers.

What is the relationship between marginal product and average product as depicted in the script?

The script illustrates that marginal product initially rises and then falls, while average product also rises and then falls, but at a slower rate. Marginal product cuts average product at its highest point.

Why does the marginal product start to decrease after a certain point in the script's example?

In the script's example, the marginal product starts to decrease after the third worker is hired because the fixed factors of production (ovens and workspace) become a constraint, leading to diminishing returns.

What are the two reasons for increasing labor productivity when the first few workers are hired, as mentioned in the script?

The two reasons for increasing labor productivity are specialization and underutilization of fixed factors of production. Workers can specialize in different tasks, and there is enough fixed capital (like ovens) and space for them to work without hindering each other.

How does the law of diminishing returns explain the shape of cost curves in the short-run for a firm?

The law of diminishing returns can explain the shape of cost curves in the short-run by showing that as more workers are hired, the marginal product and thus total cost will initially decrease, but eventually increase due to the fixed factors of production becoming a constraint.

What is the significance of the point where marginal product is zero in relation to total product?

The point where marginal product is zero is significant because it represents the maximum level of total product. Beyond this point, adding more workers would decrease total product due to the negative impact of diminishing returns.

How does the script use the example of a pizza-making business to illustrate the law of diminishing returns?

The script uses a pizza-making business as an example to show how the total, marginal, and average product change as more workers are hired. It demonstrates how the law of diminishing returns affects these measures as the business reaches the limits of its fixed factors of production.

Outlines

00:00

📈 Understanding the Law of Diminishing Returns

The first paragraph introduces the concept of the law of diminishing marginal returns in the context of business operations. It explains that in the short run, where at least one factor of production is fixed, businesses can only increase output by adding labor, which is the variable factor. The law suggests that adding labor to a fixed amount of capital and land will initially increase total product but will eventually lead to a decrease in marginal product. The paragraph discusses the importance of understanding this relationship for businesses, especially in mapping the returns to labor through diagrams showing total product, marginal product, and average product. It uses the example of a pizza-making business to illustrate how the law affects the output when workers are added incrementally, highlighting the transition from increasing to decreasing marginal product as workers are added beyond a certain point.

05:00

🔍 Deep Dive into Labor Productivity and Fixed Factors

The second paragraph delves deeper into the reasons behind the law of diminishing returns by focusing on labor productivity and the utilization of fixed factors of production. It discusses two primary reasons for increasing productivity when the first few workers are added: specialization and underutilization of fixed factors. As workers learn from each other and specialize in different tasks, such as applying sauce or manning ovens, productivity increases. Additionally, the underutilization of fixed factors like ovens and workspace allows each new worker to contribute more output. However, once the fixed factors become a constraint, such as when there are not enough ovens for all workers, productivity begins to decrease. This leads to a decline in marginal product as each new worker adds less to the output than the previous one. The paragraph also explains how total product increases but at a decreasing rate before it starts to fall, with the total product being maximized when marginal product reaches zero. This is a crucial concept as it shows the practical application of the law of diminishing returns in determining optimal labor levels for a firm.

Keywords

💡Law of Diminishing Marginal Returns

The law of diminishing marginal returns is a fundamental economic concept that states as more units of a variable input are added to a fixed input, the incremental output will eventually decrease. In the context of the video, this law is used to explain why a business might initially increase its output by adding more workers (variable input), but after a certain point, the additional output from each new worker will start to decrease due to the constraints of fixed factors of production like capital and land.

💡Short-run

The short-run in economics refers to a period of time during which at least one factor of production is fixed, while other factors can be varied. The video emphasizes that in the short-run, businesses may have fixed capital and land, and can only increase output by adding labor. This concept is crucial for understanding how the law of diminishing returns affects businesses in the short-run as they try to increase production by hiring more workers.

💡Fixed Factors of Production

Fixed factors of production are the inputs in a production process that cannot be changed in the short-run. In the video script, examples of fixed factors are given as 'capital' (like ovens in a pizza-making business) and 'land' (the workspace). These factors are contrasted with variable factors, which can be adjusted, such as the number of workers. The concept is key to understanding the limitations businesses face in the short-run when trying to increase output.

💡Variable Factors of Production

Variable factors of production are inputs that can be changed or adjusted in the short-run to affect output. Labor is highlighted as the variable factor in the video, where businesses can increase the number of workers to increase production. The video explains how the law of diminishing returns impacts the effectiveness of adding more variable factors once the fixed factors are fully utilized.

💡Total Product (TP)

Total product refers to the total quantity of output produced by a business. In the video, TP is used to illustrate how the number of pizzas made in an hour changes as more workers are added. The video explains that TP initially increases as more workers are added, but the rate of increase slows down and eventually TP can start to decrease, which is a direct result of the law of diminishing returns.

💡Marginal Product

Marginal product is the additional output produced by adding one more unit of the variable input while holding all other inputs constant. The video explains how to calculate marginal product by looking at the change in total product divided by the change in the quantity of workers. It is a critical concept for understanding the law of diminishing returns, as it shows how the extra output from each new worker starts to decrease after a certain point.

💡Average Product

Average product is calculated by dividing the total product by the number of workers. It represents the output per worker. The video uses average product to demonstrate how the efficiency of workers changes as more workers are added. Initially, average product increases due to specialization and underutilization of fixed factors, but it starts to decrease as the law of diminishing returns sets in.

💡Specialization

Specialization in the context of the video refers to the division of labor among workers, where each worker focuses on a specific task, leading to increased efficiency. The video explains that when a business first starts to add workers, they can experience increasing returns due to workers specializing in different aspects of pizza making, such as applying sauce or managing the ovens.

💡Underutilization of Fixed Factors

Underutilization of fixed factors occurs when there is excess capacity in the fixed inputs, allowing additional workers to utilize these underused resources. The video uses the example of ovens and workspace to illustrate how the first few workers can increase productivity by making use of these underutilized fixed factors, leading to higher marginal and average products.

💡Cost Curves

Cost curves in economics represent the relationship between the cost of production and the level of output. The video suggests that the law of diminishing returns can also explain the shape of cost curves in the short-run for a firm. As the marginal product decreases, the cost of producing additional units increases, which can be reflected in the upward slope of cost curves as output levels increase.

Highlights

The law of diminishing marginal returns affects businesses in the short run, where at least one factor of production is fixed.

In the short run, businesses can only increase output by adding labor, assuming capital and land are fixed.

The law of diminishing returns states that as more labor is added to a fixed amount of capital and land, total product will initially rise and then fall.

The marginal product is calculated as the change in total product divided by the change in the quantity of workers.

Average product is total product divided by the number of workers, and it initially rises then falls due to diminishing returns.

The marginal product curve initially rises with increasing labor productivity due to specialization and underutilization of fixed factors.

After a certain point, the marginal product curve falls as fixed factors become a constraint, leading to decreasing labor productivity.

The marginal product curve cuts the average product curve at its highest point, indicating the peak efficiency of labor.

Total product increases at a decreasing rate until it reaches a maximum when marginal product is zero.

The law of diminishing returns can explain the shape of cost curves in the short run for a firm.

Specialization among workers leads to increased productivity in the initial stages of hiring.

Underutilization of fixed factors like ovens and workspace allows for increased productivity until they become limiting factors.

The transition from increasing to decreasing marginal product marks the point where the law of diminishing returns sets in.

The total product curve peaks when the marginal product is zero, indicating no additional output from hiring more workers.

The law of diminishing returns is a fundamental concept for understanding production efficiency and cost structures in economics.

The practical application of this law helps businesses optimize their production by understanding the relationship between labor and output.

Transcripts

hi everybody the law of diminishing

marginal returns is a phenomenon that

will affect the business in the short

run ie when there is at least one fixed

factor of production that's our

definition of the short-run

a period of time where there is at least

one fixed factor of production normally

two normally capital and land are fixed

for a business in the short-run and

therefore the only way to increase

output is to increase labor we assume

labor to be our variable factor of

production and then if we actually map

numbers here as to what happens when

businesses increase labor in the short

run we get a very interesting pattern

that can be explained by the law of

diminishing returns and the law of

diminishing returns states that in the

short-run when variable factors of

production ie labor are added to a stock

of fixed factors of production on land

and capital total or marginal product

will initially rise and then fall it's a

very interesting phenomenon and a very

interesting thing for a business to know

if they're in the short-run what we want

to do is illustrate the relationship

between employee more workers or

quantity of workers and the output we

get as a return their returns to labor

we want to map that on diagrams using

curves we want to draw marginal product

average product total product and help

explain the law of diminishing returns

for us to do that I've put this table

here on the left-hand side and these

numbers represent let's say a business

that is making pizzas yeah so pizza

making business right here and let's say

that this business is in the short-run

they have a fixed amount of capital

let's say three ovens and a fixed amount

of land let's say work space enough for

three workers here okay so this business

is in the short-run

but the business is employing more and

more workers to try and get more pizzas

made in a given hour let's say and as

they employ more workers let's see these

are the total number of pizzas made in

an hour so TP is for total product and

we have these numbers a very interesting

relationship well we want to work out is

the marginal product and the average

product - the equation for marginal

product is the change in total product

divided by the change in the quantity of

workers just think of marginal as extra

so here the extra product the

strap output product this means output

the extra output when we employ one more

worker well in this case the change in

the quantity of work is always 1 so it's

very simply just the change in TP so the

marginal product when we employ the

first worker is for the second worker

bringing an extra five the third worker

brings in an extra six the fourth worker

and x4 to the fifth worker 1 and when we

employ the sixth worker minus three very

interesting relationship

what about average product average

product is is total product divided by

the quantity of workers so four divided

by one is 4 9 divided by 2 4.5 15

divided by 3 is 5 17 divided by 4 for

0.25 18 divided by 5 this is 3 point 6

15 divided by 6 is 2 point 5 so there

are numbers there great well we can now

do is put those numbers onto diagrams

what I want to plot first is marginal

product and average product now what I

could do is do it actual plot a proper

plot here putting these numbers on the

diagram you can do that if you want I'm

just gonna take the rough shape from

these numbers and we can very clearly

see take average product first average

product Rises initially and then it

starts to fall so average product is

going to look something like that that's

gonna be our average product curve there

and what about marginal product marginal

product follows the same relationship

but it goes a bit higher doesn't it so

it goes up and then it starts to fall

much more steeply than average product

does the marginal product is going to

look something like that

there's our marginal product fair

brilliant so we've got two curves

marginal product an average product and

it's very important guys when you draw

the marginal product curve it's got a

cut average product at its highest point

this is something I explained later in

this playlist but you've got to draw it

so marginal product cuts average product

at its highest point and we have some

very interesting shapes and we can

explain the shapes what I'm gonna do I'm

going to break down the marginal product

curve into two sections I'm gonna call

that section 1 when the curve is rising

and then when the curve is falling I'm

going to call that section 2 now let's

have a look and see what's going on here

when we employ our first few workers we

can see that marginal product is rising

each worker

each additional worker is bringing in

more output than the last more pizzas

made than the last person but then once

we employ our fourth worker we can see

that marginal product starts to fall

from 6 to 2 then to 1 then 2 minus 3 we

get into the part of the curve where

marginal product is decreasing and that

is because the law of diminishing

returns sets in when we employ our

fourth worker so let's explain what's

happening in stage 1 when we employ our

first few workers our first 3 workers in

particular here we are seeing increasing

returns to labour marginal product is

rising why is that and that is because

labor productivity is increasing for two

reasons one there is specialisation

taking place so as we employ the second

worker he's learning from the first

worker absolutely in how to make pizzas

fast when we employ the third work and

the same thing is happening they are

learning from the previous two workers

they are specializing as well so maybe

one person is applying sauce one person

toppings one person Manning the ovens

absolutely the case or ser

specialization potentially like that but

also there is under utilization of our

fixed factors of production there are

excess ovens right so maybe when we

employ our second worker the second

worker can also use an oven our third

worker can also use an oven there are

three ovens so each person can use an

oven there is enough work space for

three workers so when we employ a second

worker they can use the excess work

space the third worker can use excess

work space absolutely so there is under

utilization of fixed factors of

production and there is specialization

between these workers which means that

labor productivity is rising and

therefore marginal product is increasing

but when we employ our fourth worker

marginal product starts to fall labor

productivity decreases and that is

because of fixed factors of production

become a constraint on production what

does that mean means very simply there

aren't enough fixed factors of

production to take more than three

workers here there aren't enough ovens

there is enough work space so workers

start again in the way of one another

they start to affect each other's output

and therefore labor productivity Falls

as a result and we get this relationship

average product is shape

in exactly the same way for the same

reason so that explains how the law of

diminishing returns can affect a firm's

marginal product average product in the

short run here absolutely what we can

also do is look how we can apply this

concept a total product let's do that

here we can see from our total product

numbers that total Prada will increase

but can you see at a slower rate before

it eventually starts to fall and we can

map that on a diagram here the crucial

thing is that total product will be

maximized when marginal product is 0 so

it's gonna look something like this it's

gonna rise at a slower rate hit its peak

where marginal product is 0 and then

fall that's gonna be our total product

curve like that absolutely now why does

it peak when marginal product is 0

why is TP maximized when marginal

product is 0 well we can see that a

marginal product is negative total

product is going to be falling so that

can't be maximizing TP and if marginal

product is positive then each next

worker heid is going to bring in more

output and therefore total product is

going to keep rising so as long as

marginal product that's positive the

next worker is going to bring in more

output and that's going to keep

increasing TP so therefore the only

point my total product is maximized is

when there is no more marginal product

left ie when marginal product is 0 there

is no more marginal product to bring in

so that's a crucial rule you have to

take away so that guys covers the law of

diminishing returns and you can explain

and very clearly see from this

definition how well when we increase

workers in the short-run there is going

to be an initial increase before

marginal product the total product start

to decrease and that can be explained

simply by what's in blue at the bottom

here the law of diminishing returns can

also explain the shape of many cost

curves in the short-run for a firm so

make sure that your to the next few

videos in this playlist to fully

understand how the shape of these cost

curves can be explained by the law of

diminishing returns thank you so much

for watching guys I'll see you in those

videos

[Music]