Economics-Discussion 2

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THE LAW OF DIMINISHING MARGINAL RETURNS 1 The Law of Diminishing Marginal Returns Pavithra Elangovan University of the Cumberlands BADM-535-A02- Managerial Economics Iddisah Sulemana September 7, 2023

THE LAW OF DIMINISHING MARGINAL RETURNS 2 The Law of Diminishing Marginal Returns In the world of economics, I have learned that an essential principle that governs production dynamics is the law of diminishing marginal returns (Layson, 2015). This principle states that when a company increases its production, the extra output gained from using one more unit of input starts to decrease. For example, in a factory, at first, adding more workers to a production line can boost output in a balanced way. But after a certain point, adding more workers may lead to a smaller increase in output. Undoubtedly, a point is reached where each additional input yields diminishing returns, affecting the overall productivity adversely. At this moment, each new input unit contributes less and less to the total output, thereby signaling a decrease in input effectiveness. This phenomenon is instrumental for corporations aiming to fine-tune production scales and to preserve an optimal equilibrium between the inputs utilized and the outputs achieved (Anisimov et al., 2017). Furthermore, the increase in marginal costs plays a crucial role in evaluating the economic feasibility of different production activities. When marginal costs go up, average costs also rise, which makes it more challenging to determine break-even prices. These break-even prices are essential in negotiations for contracts. These economic factors require a thorough understanding and strategic approach when making contract agreements to protect the financial well-being of the business. Understanding the complex cost curves becomes an essential skill in avoiding contracts that might end in unprofitable prices. Concurrently, it is important to discern the scenarios wherein a firm experiences increasing returns to scale, characterized by a decline in average costs with a rise in output. In such circumstances, a strategic focus on securing sales that facilitate lower costs becomes vital. Additionally, when offering suppliers substantial orders that

THE LAW OF DIMINISHING MARGINAL RETURNS 3 grant them the leverage to realize economies of scale, astute negotiation strategies to partake in their profit margins by advocating for reduced prices can be a viable approach. This analytical and strategic thought process enables firms to forge mutually beneficial contracts and foster sustainable business relationships. Discussion Question As part of a deliberate effort to improve operational efficiency, our company allocated a significant sum of $5 million for the acquisition and implementation of an advanced Enterprise Resource Planning (ERP) system over a five-year period. This financial commitment led to noticeable opportunity costs, primarily involving forgoing the option of investing the capital in a diversified investment portfolio, potentially yielding an annual return of around 6%. The advantages stemming from this strategic decision are diverse. The envisioned ERP system serves as a potent tool for streamlining business processes, facilitating data-driven decision-making, and boosting overall productivity. These improvements propel the organization toward a path of sustained growth and innovation. In hindsight, this strategic move aligns perfectly with the company's vision of embracing technological advancements to optimize its operations. To gauge the financial implications of this investment, the Net Present Value (NPV) is calculated below to determine if it was profitable. Assuming a discount rate of 5% and foreseeing an annual benefit of $1.2 million over the five-year, the NPV is calculated as NPV=∑R/(1+r)^t-I NPV=1.2/(1+0.05)^1+1.2/(1+0.05)^2+1.2/(1+0.05)^3+1.2/(1+0.05)^4+1.2/(1+0.05)^5 =5.195

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THE LAW OF DIMINISHING MARGINAL RETURNS 4 The net present value is positive indicating that this investment was profitable.

THE LAW OF DIMINISHING MARGINAL RETURNS 5 References Layson, S. K. (2015). The increasing returns to scale CES production function and the law of diminishing marginal returns. Southern Economic Journal , 82 (2), 408-415. Anisimov, V. G., Anisimov, E. G., Saurenko, T. N., & Sonkin, M. A. (2017). The model and the planning method of volume and variety assessment of innovative products in an industrial enterprise. In Journal of Physics - Conference Series (Vol. 803, No. 1, p. 012006). IOP Publishing.

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