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Inputs and Outputs of Production

Marginal Product

The marginal product of an input is the extra output generated by adding one more unit of that input.

The marginal product (MP) of an input is the extra output (the amount produced) generated by adding one more input unit. For example, the marginal product of labor is the additional output resulting from hiring another worker. The marginal product of capital (wealth or money used to start and maintain a business) is additional output that results from adding one unit of capital, and the marginal product of land is the additional output from adding another unit of land. The marginal product is usually measured in physical units, such as the number of cars or tons of steel. While one input is increased, the other inputs are held fixed (the ceteris paribus assumption, meaning that all other factors stay the same), so the ratio of production inputs varies as more of the input is added.

Typically, at low levels of output, increases in an input raise total output at a growing rate, so the marginal product of that input is positive. When further inputs result in a slower rate of increase in total product, the marginal product, while still positive, starts to be reduced. When an increase in the input decreases the total output, marginal productivity is negative. The law of diminishing marginal returns is the observation in the short run that each additional unit of a production input, holding all other inputs fixed, will yield progressively smaller increases in output. The rate of increase in output slows down, eventually reducing the output.

Marginal Product Curve

The marginal product curve is hump-shaped. It shows that, holding all other inputs constant, an additional unit of a single input, such as labor, initially produces increasing amounts of output. For example, multiple shifts of workers could use the same equipment to produce more products. As the quantity of inputs increases, an additional unit of input produces fewer additional units of output. Both workers and machinery need down time for rest and repair. Eventually, an additional unit of input produces a negative impact on units of output. Only so many workers can share the same space and machinery before working conditions become too crowded and machinery begins to break down from overuse.
As increments of one input are added, a point is reached after which the return achieved from each additional input falls, eventually becoming negative. An example is when extra workers are hired and raw material is ordered to be used with an expensive piece of machinery that cannot be quickly replaced. Diminishing returns eventually become negative returns when the addition of one unit of input actually causes a reduction in total output.

The law of diminishing returns is based on several assumptions. First, technology is assumed to be constant, so there is, for example, no improvement in output per worker or per machine as a result of technological progress. Second, all units of variable factors of production are assumed to be homogeneous (the law would not necessarily hold if, for example, the new hires were stronger or better trained than their predecessors, or if the quality of a raw material was far worse or far better than the one used before). Third, the product has to be measurable in physical units such as weight or volume. Changing one input and holding the other inputs stable (in the short run) results in a change in the ratio of inputs to each other. The law of diminishing returns is therefore also known as the law of variable proportions.