Law of Diminishing Returns

Given that technology is fixed and techniques of production don’t change;

“If successive units of variable resource for example labor are added to fixed resource for example capital beyond some point marginal product associated with each extra unit of variable resource will decline.”

This law is also called law of diminishing marginal product or law of variable proportions for example if a plant adds one worker, total production will increase by 100 units suppose it’ and adding second worker may increase production by 90 units. Adding more and more workers will increase output with decreasing amount. Still adding more workers results in overcrowding and then the extra output of a new worker might decline.

There is a link between marginal return, total product and Average product. When marginal product is rising total product increases at an increasing rate. When Marginal product is positive but falling total product increases at a decreasing rate. When marginal product is negative total product start declining. When marginal product is more than average product the average product raises when marginal product less than average product, average product falls.

Short Run Production Cost

Fixed cost is the cost which remain same regardless the level of output. They must be paid even if output is 0 and they don’t increases as the firm produces more for example the rental payments, interest and insurance.

Variable cost is the cost that changes the level of output. They include payments for materials, fuel, labor and transportation etc. In the short run the firm manager have no control over the fixed cost. Variable cost can be controlled by changing the production level, fixed cost remains the same but variable cost increases initially with decreasing amount then after a certain point. Total cost is sum of the variable cost and fixed cost it shows the same pattern as variable cost.

As production raises Average fixed cost declines more and more. This is called “Spreading the Overhead”. Average variable cost first declines and then rises when we start producing more, initially the marginal product is greater so Average variable cost declines , later on marginal product declines so average variable cost start rising.

Average total cost follows the same path as average variable cost. Marginal cost first declines sharply, then starts rising. It crosses average variable cost and average total cost at their minimum points. When Marginal cost is below Average variable cost, variable cost or Average variable cost these both curve declines. Marginal cost cuts Average total cost and Average variable cost at their minimum points. When Marginal cost is above average variable cost, variable cost or average variable cost these both curve rises.

Marginal cost data is very important because it shows how much extra we have to pay for producing one more unit. In other words how much can be saved by not producing the last unit.

business economics

March 13, 2019