Assumptions of marginal productivity theory:

The marginal productivity theory depends on the assumptions illustrated below:

1. There is perfect competition.

2. Each units of a factor are homogeneous. This means that one unit of a factor is similar as the other.

3. Factors can be replaced for each other. That is, every factor is interchangeable.

4. The theory depends on the law of diminishing returns as exerted to the business. The law of diminishing returns states that when you go on utilizing more and more units of a factor, its marginal returns will reduce. Therefore a firm, whenever it comes to know that the raise in a certain factor is resultant in diminishing returns, then the firm will replace it with certain other factor.

Thus, it will try to decrease the cost of production.

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