What are Diminishing Marginal Returns?

Diminishing marginal returns is an economic theory stating that, all else being equal, the output for each producing unit will eventually decrease once a certain number of producing units is realized. This is a very important concept for those in business as it means that hiring new employees will actually decrease efficiency at some point. Managers must always keep this in mind as they strive to maintain the most efficient operation possible.

It should be noted that the law of diminishing marginal returns does not predict that overall output will decrease, Rather, it predicts the output produced, per employee, or producing unit, will decrease after a certain point. This could be due to a number of different factors.

For example, if 5 employees can produce 100 widgets in an hour's time, it may be assumed that 10 employees may be able to produce 200 widgets in that same time frame. However, that may not be the case. Production could be dependent on available space and speed of automated processes.

For example, putting more people at a table may decrease efficiency if people are getting in the way of each other or waiting to use other resources. Idle time is one of the biggest factors in efficiency measures. Therefore, there may need to be other production inputs considered if diminishing marginal returns are to be avoided.

Thus, diminishing marginal returns only become a reality, in most cases, when one production input increases but others fail to keep up. Therefore, those with a background in economics will realize that simply increasing the number of workers may not lead to gains in efficiency without other investments. In some cases, these other investments may be as simple as a new line or even more workspaces.

However, often it takes a significant investment in order to subvert the law of diminishing returns. For example, it may take an entire new production facility. This is because businesses often try to make as much use out of existing space as possible. Most simply do not have enough space to increase production capacity to substantial levels without creating inefficiencies.

It should also be noted that diminishing marginal returns may not preclude a manager from hiring more individuals despite a projected decrease in productivity. For example, using the widgets, if an order suddenly comes in for many widgets, the manager may hire more workers to fill it, even if it means less productivity. In the end, regardless of diminishing marginal returns, fulfilling the order may be seen as more important than any costs associated with decreased efficiencies.