p. 144 A firm's costs of producing a specific output depend on the prices of the needed resources and the quantities of resources (inputs) needed to produce that output. Resource supply and demand determine resource prices. The technological aspects of production, specifically the relationships between inputs and output, determine the quantities of resources needed. Our focus will be on the labor-output relationship, given a fixed plant capacity. But before examining that relationship, we need to define three terms:
Average product (AP)The total output produced per unit of a resource employed (total product divided by the quantity of that employed resource)., also called labor productivity, is output per unit of labor input:  Law of Diminishing Returns
The answers are provided in general terms by the law of diminishing returnsThe principle that as successive increments of a variable resource are added to a fixed resource, the marginal product of the variable resource will eventually decrease.. This law assumes that technology is fixed and thus the techniques of production do not change. It states that as successive units of a variable resource (say, labor) are added to a fixed resource (say, capital or land), beyond some point the extra, or marginal, product that can be attributed to each additional unit of the variable resource will decline. For example, if additional workers are hired to work with a constant amount of capital equipment, output will eventually rise by smaller and smaller amounts as more workers are hired. Rationale Suppose a farmer has a fixed resource—80 acres of land—planted in corn. If the farmer does not cultivate the cornfields (clear the weeds) at all, the yield will be 40 bushels per acre. If he cultivates the land once, output may rise to 50 bushels per acre. A second cultivation may increase output to 57 bushels per acre, a third to 61, and a fourth to 63. Succeeding cultivations will add less and less to the land's yield. If this were not so, the world's needs for corn could be fulfilled by extremely intense cultivation of this single 80-acre plot of land. Indeed, if diminishing returns did not occur, the world could be fed out of a flowerpot. Why not? Just keep adding more seed, fertilizer, and harvesters!
p. 145 The law of diminishing returns also holds true in non-agricultural industries. Assume a wood shop is manufacturing furniture frames. It has a specific amount of equipment such as lathes, planes, saws, and sanders. If this shop hired just one or two workers, total output and productivity (output per worker) would be very low. The workers would have to perform many different jobs, and the advantages of specialization would not be realized. Time would be lost in switching from one job to another, and machines would stand idle much of the time. In short, the plant would be understaffed, and production would be inefficient because there would be too much capital relative to the amount of labor. The shop could eliminate those difficulties by hiring more workers. Then the equipment would be more fully used, and workers could specialize on doing a single job. Time would no longer be lost switching from job to job. As more workers were added, production would become more efficient and the marginal product of each succeeding worker would rise. But the rise could not go on indefinitely. Beyond a certain point, adding more workers would cause overcrowding. Since workers would then have to wait in line to use the machinery, they would be underused. Total output would increase at a diminishing rate because, given the fixed size of the plant, each worker would have less capital equipment to work with as more and more labor was hired. The marginal product of additional workers would decline because there would be more labor in proportion to the fixed amount of capital. Eventually, adding still more workers would cause so much congestion that marginal product would become negative and total product would decline. At the extreme, the addition of more and more labor would exhaust all the standing room, and total product would fall to zero. Note that the law of diminishing returns assumes that all units of labor are of equal quality. Each successive worker is presumed to have the same innate ability, motor coordination, education, training, and work experience. Marginal product ultimately diminishes, but not because successive workers are less skilled or less energetic. It declines because the firm is using more workers relative to the amount of plant and equipment available. Tabular Example Table 7.1 is a numerical illustration of the law of diminishing returns. Column 2 shows the total product, or total output, resulting from combining each level of a variable input (labor) in column 1 with a fixed amount of capital.
Column 3 shows the marginal product (MP), the change in total product associated with each additional unit of labor. Note that with no labor input, total product is zero; a plant with no workers will produce no output. The first three units of labor reflect increasing marginal returns, with marginal products of 10, 15, and 20 units, respectively. But beginning with the fourth unit of labor, marginal product diminishes continuously, becoming zero with the seventh unit of labor and negative with the eighth. Average product, or output per labor unit, is shown in column 4. It is calculated by dividing total product (column 2) by the number of labor units needed to produce it (column 1). At 5 units of labor, for example, AP is 14 (= 70/5). Graphical Portrayal Figure 7.2 (Key Graph) shows the diminishing-returns data in Table 7.1 graphically and further clarifies the relationships between total, marginal, and average products. (Marginal product in Figure 7.2b is plotted halfway between the units of labor since it applies to the addition of each labor unit.) p. 146
p. 147 Note first in Figure 7.2a that total product, TP, goes through three phases: It rises initially at an increasing rate; then it increases, but at a diminishing rate; finally, after reaching a maximum, it declines. Geometrically, marginal product—shown by the MP curve in Figure 7.2b—is the slope of the total-product curve. Marginal product measures the change in total product associated with each succeeding unit of labor. Thus, the three phases of total product are also reflected in marginal product. Where total product is increasing at an increasing rate, marginal product is rising. Here, extra units of labor are adding larger and larger amounts to total product. Similarly, where total product is increasing but at a decreasing rate, marginal product is positive but falling. Each additional unit of labor adds less to total product than did the previous unit. When total product is at a maximum, marginal product is zero. When total product declines, marginal product becomes negative. Average product, AP (Figure 7.2b), displays the same tendencies as marginal product. It increases, reaches a maximum, and then decreases as more and more units of labor are added to the fixed plant. But note the relationship between marginal product and average product: Where marginal product exceeds average product, average product rises. And where marginal product is less than average product, average product declines. It follows that marginal product intersects average product where average product is at a maximum.
This relationship is a mathematical necessity. If you add a larger number to a total than the current average of that total, the average must rise. And if you add a smaller number to a total than the current average of that total, the average must fall. You raise your average examination grade only when your score on an additional (marginal) examination is greater than the average of all your past scores. You lower your average when your grade on an additional exam is below your current average. In our production example, when the amount an extra worker adds to total product exceeds the average product of all workers currently employed, average product will rise. Conversely, when the amount an extra worker adds to total product is less than the current average product, average product will decrease. The law of diminishing returns is embodied in the shapes of all three curves. But, as our definition of the law of diminishing returns indicates, economists are most concerned with its effects on marginal product. The regions of increasing, diminishing, and negative marginal product (returns) are shown in Figure 7.2b. |
What do you call to the relationship between the maximum amounts of output that can be produced and the inputs required to make that output?
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