Yeah there are certainly diminishing returns. It's just that if they had N employees today, it's very unlikely they were at the top of their s-curve, such that N+1 employees is now net negative. Unless the business was already very mature. Most companies are expecting to grow revenue.

So it would be the exceptional case that firing employees because they were suddenly more productive makes sense.

What's more likely is they were already overhired and the new found "efficiency" is the excuse to resize.

Edit: btw this comes up IRL for me all the time in my work. Companies default play is to cut expenses to hit desired margin. It's much more beneficial in most cases to keep the team but increase their efficiency and handle more revenue. There are diminishing returns to profit by cutting back.