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Applied Problems Week 4

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Background Information: The theory of diminishing returns

In the production theory of Micro- Economics, when we focus on results, we talk in terms of returns. This means that production with no returns would not be worth the investment of factors of production. These factors of production include: Land, labor, Capital and entrepreneurship. In modern Economics, scholars are arguing that the fifth factor of production is Information. Basically, in any good scenario, every factor of production is expected to yield returns. In this regard, the returns for land, labor, capital and entrepreneurship are rent, wages, interest and profit respectively. Ideally thinking, when a producer invests more factors of production, there should be a proportionate increase in returns (we can dub this “The theory of increasing returns”). However, this notion of increasing returns is unrealistic. It is important to note that when a producer adds more of a factor of production to another that is held constant, when all other factors are held constant (ceteris paribus), returns will increase at a decreasing rate up to a point where the curve flattens off and beyond this point, the curve regresses downwards. This is called the theory of diminishing returns. Some scholars will also call it on a light note, “The theory of variable proportions”. In this case therefore, the argument is that when we add more a variable factor of production (an example of land) to a fixed factor of production (Land), we may not realize a proportionte increase in the returns.

Specific Answer Proposition: “A manager should never hire another worker if the new person causes diminishing returns”

This statement is absolutely correct in accordance with the theory of diminishing returns. The optimum point of adding a variable factor of production is the point at which the graph levels off. This is because the producer will have enjoyed all the increasing returns. It is important to note that even when the returns are increasing at a decreasing rate, it would still be rational to add variable factors of production (an example of labor in the illustration above) since the net effect will be a total increase in returns.

The extent to which the statement is correct is that when the curve starts to regress downwards, it is irrational to add a worker. This is because this addition will have negative returns.

 Analysis of the Question:

We notice that the Marginal product of labor used in the Printer equals the Wage level. The Marginal product of presses is 5 times less than the wage cost incurred.

From the above analysis, it is easily seen that the Press line is operating uneconomically because the an additional unit of labor will cost more than it yields (in terms of returns)

To this end, it therefore clear that the input choice is not optimal.

Suggested optimal input adjustment

Since the marginal product of labor used in the printers covers the cost of labor incurred and the case for the presses is the opposite, I woulld therefore suggest that the marginal input on the press line be shifted to the printing line. This will alleviate the effects of diminishing returns

Current production per day = 5400 units

Specific Answer:

(a)   Let us compute the Marginal Product Versus labor ratio

MPL Ratio= Marginal Product of Labor (Units)/Cost per day

                  = 200/50

MPM Ratio= Marginal Product of Machine (Units)/Cost per day

                  = 1800/600

                  = 3

From the above computation, we see that Marginal Product of human labor is greater than that of Machine labor. It follows that we cannot better increase the production per day using the machine than using the human labor

(b)   If the cost of labor goes up, this will affect the ratio as follows|:

MPL Ratio= Marginal Product of Labor (Units)/Cost per day

                  = 200/100

The effect of the above changes to the decision will be that now it will be more economical to use the machine. This is because the MPM ratio remains at 3, while the MPL ratio comes down to 2.

This result therefore reverses the decision made in (a) above.

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