Every organization aims at maximizing on the earned revenue and minimizing the costs incurred. However, the ability of the firm to achieve these objectives is usually met with some difficulties that are associated with factor inputs. Company management is responsible for making optimal decisions regarding the various levels of inputs and activities in the firm. The management is required to analyze the benefits that accrue from each individual employee and compare it with the costs of the employee given the working conditions of the firm. Normally, the marginal productivity of labor would decline with an increase in the number of employees in the short term. This paper discusses the law of diminishing marginal benefits of labor.
Law of Diminishing Returns
According to Maurice & Thomas (2008), every firm desires to maximize profit. However, the costs of operating the organization and producing output weigh down heavily on the firm revenues. Marginal analysis is a method that is utilized by the management to reach optimal decisions of the firm. Using this method enables the management to weigh the ability of adjusting a given variable either up or down. The guiding principle is the effect of the changes on the benefits received from the labor changes and the costs incurred.
Marginal benefit is the benefit that results from a unit increase in the use of labor. Marginal cost is the cost that results from an increase in the use of an extra unit of labor when all other factors are held constant. Normally, when all other factors are held constant, an increase in labor results in marginal increase of the productivity of labor. According to Besanko, the total product increases at an increasing rate, then at a decreasing rate and thereafter, the total product begins to decrease. The law of diminishing marginal returns hypothesizes that “as the firm combines more of a variable factor and a fixed factor of production in the short run, the marginal product of the variable factor eventually declines” (Besanko, 2010, p. 206).
The output of a firm increases by less and less with each additional employee due to the fixed factor of production. In the short term, not all variables of production vary. Some factors such as labor can vary while other variables such as land are fixed. The fixed production factor imposes constraints on production in the short term. Given the fixed factor of production, a firm can increase its employees and result in higher marginal productivity and total output. However, after some time, the firm becomes crowded and as more workers are employed in the firm, their marginal productivity declines. Due to declining marginal product associated with each new employee, the total product of the firm will also decrease. Therefore, the firm should always produce at that level where it realizes the maximum marginal product and where the marginal benefits equal to marginal costs (Maurice & Thomas, 2008).
The law of diminishing marginal benefits is important in explaining why the total product of a firm can decrease with the addition of more employees to the fixed factor of production. Addition of more variable factors to a fixed factor of production can lead to overcrowding and result in diminishing marginal returns and total product. Profit maximizing management should decide to produce at the level where the marginal product of the firm is highest and where marginal benefits equal marginal costs.
Besanko, D., Braeutigam, R. & Braeutigam, R. (2010). Microeconomics. 4 Ed. NJ, New jersey: John Wiley & Sons.
Maurice, S., & Thomas, C. (2008). Managerial Economics. 9 Ed. New York, NY: McGraw-Hill.