hi everybody the law of diminishing marginal returns is a phenomenon that will affect the business in the short run ie when there is at least one fixed factor of production that's our definition of the short-run a period of time where there is at least one fixed factor of production normally two normally capital and land are fixed for a business in the short-run and therefore the only way to increase output is to increase labor we assume labor to be our variable factor of production and then if we actually map numbers here as to what happens when businesses increase labor in the short run we get a very interesting pattern that can be explained by the law of diminishing returns and the law of diminishing returns states that in the short-run when variable factors of production ie labor are added to a stock of fixed factors of production on land and capital total or marginal product will initially rise and then fall it's a very interesting phenomenon and a very interesting thing for a business to know if they're in the short-run what we want to do is illustrate the relationship between employee more workers or quantity of workers and the output we get as a return their returns to labor we want to map that on diagrams using curves we want to draw marginal product average product total product and help explain the law of diminishing returns for us to do that I've put this table here on the left-hand side and these numbers represent let's say a business that is making pizzas yeah so pizza making business right here and let's say that this business is in the short-run they have a fixed amount of capital let's say three ovens and a fixed amount of land let's say work space enough for three workers here okay so this business is in the short-run but the business is employing more and more workers to try and get more pizzas made in a given hour let's say and as they employ more workers let's see these are the total number of pizzas made in an hour so TP is for total product and we have these numbers a very interesting relationship well we want to work out is the marginal product and the average product - the equation for marginal product is the change in total product divided by the change in the quantity of workers just think of marginal as extra so here the extra product the strap output product this means output the extra output when we employ one more worker well in this case the change in the quantity of work is always 1 so it's very simply just the change in TP so the marginal product when we employ the first worker is for the second worker bringing an extra five the third worker brings in an extra six the fourth worker and x4 to the fifth worker 1 and when we employ the sixth worker minus three very interesting relationship what about average product average product is is total product divided by the quantity of workers so four divided by one is 4 9 divided by 2 4.5 15 divided by 3 is 5 17 divided by 4 for 0.25 18 divided by 5 this is 3 point 6 15 divided by 6 is 2 point 5 so there are numbers there great well we can now do is put those numbers onto diagrams what I want to plot first is marginal product and average product now what I could do is do it actual plot a proper plot here putting these numbers on the diagram you can do that if you want I'm just gonna take the rough shape from these numbers and we can very clearly see take average product first average product Rises initially and then it starts to fall so average product is going to look something like that that's gonna be our average product curve there and what about marginal product marginal product follows the same relationship but it goes a bit higher doesn't it so it goes up and then it starts to fall much more steeply than average product does the marginal product is going to look something like that there's our marginal product fair brilliant so we've got two curves marginal product an average product and it's very important guys when you draw the marginal product curve it's got a cut average product at its highest point this is something I explained later in this playlist but you've got to draw it so marginal product cuts average product at its highest point and we have some very interesting shapes and we can explain the shapes what I'm gonna do I'm going to break down the marginal product curve into two sections I'm gonna call that section 1 when the curve is rising and then when the curve is falling I'm going to call that section 2 now let's have a look and see what's going on here when we employ our first few workers we can see that marginal product is rising each worker each additional worker is bringing in more output than the last more pizzas made than the last person but then once we employ our fourth worker we can see that marginal product starts to fall from 6 to 2 then to 1 then 2 minus 3 we get into the part of the curve where marginal product is decreasing and that is because the law of diminishing returns sets in when we employ our fourth worker so let's explain what's happening in stage 1 when we employ our first few workers our first 3 workers in particular here we are seeing increasing returns to labour marginal product is rising why is that and that is because labor productivity is increasing for two reasons one there is specialisation taking place so as we employ the second worker he's learning from the first worker absolutely in how to make pizzas fast when we employ the third work and the same thing is happening they are learning from the previous two workers they are specializing as well so maybe one person is applying sauce one person toppings one person Manning the ovens absolutely the case or ser specialization potentially like that but also there is under utilization of our fixed factors of production there are excess ovens right so maybe when we employ our second worker the second worker can also use an oven our third worker can also use an oven there are three ovens so each person can use an oven there is enough work space for three workers so when we employ a second worker they can use the excess work space the third worker can use excess work space absolutely so there is under utilization of fixed factors of production and there is specialization between these workers which means that labor productivity is rising and therefore marginal product is increasing but when we employ our fourth worker marginal product starts to fall labor productivity decreases and that is because of fixed factors of production become a constraint on production what does that mean means very simply there aren't enough fixed factors of production to take more than three workers here there aren't enough ovens there is enough work space so workers start again in the way of one another they start to affect each other's output and therefore labor productivity Falls as a result and we get this relationship average product is shape in exactly the same way for the same reason so that explains how the law of diminishing returns can affect a firm's marginal product average product in the short run here absolutely what we can also do is look how we can apply this concept a total product let's do that here we can see from our total product numbers that total Prada will increase but can you see at a slower rate before it eventually starts to fall and we can map that on a diagram here the crucial thing is that total product will be maximized when marginal product is 0 so it's gonna look something like this it's gonna rise at a slower rate hit its peak where marginal product is 0 and then fall that's gonna be our total product curve like that absolutely now why does it peak when marginal product is 0 why is TP maximized when marginal product is 0 well we can see that a marginal product is negative total product is going to be falling so that can't be maximizing TP and if marginal product is positive then each next worker heid is going to bring in more output and therefore total product is going to keep rising so as long as marginal product that's positive the next worker is going to bring in more output and that's going to keep increasing TP so therefore the only point my total product is maximized is when there is no more marginal product left ie when marginal product is 0 there is no more marginal product to bring in so that's a crucial rule you have to take away so that guys covers the law of diminishing returns and you can explain and very clearly see from this definition how well when we increase workers in the short-run there is going to be an initial increase before marginal product the total product start to decrease and that can be explained simply by what's in blue at the bottom here the law of diminishing returns can also explain the shape of many cost curves in the short-run for a firm so make sure that your to the next few videos in this playlist to fully understand how the shape of these cost curves can be explained by the law of diminishing returns thank you so much for watching guys I'll see you in those videos [Music]