Analyze, with the aid of a diagram, whether there is link between diminishing returns and economies of scale. (12)
Variable factor is an input whose quantity can be changed in the time period consideration. Fixed factor is a production input factor that cannot change quantities during a certain time period. Short run is where at least one factor is fixed, usually capital. Long run is where all factors are variable
Marginal product (MP) is the extra output from hiring an additional unit of the variable factor. The MP increase first then decrease. Imagine the variable factor is labour. If the extra worker makes more units than the employees were making on average before he or she joined, the average output per worker will rise, e.g. if three workers make 9 units in total and the fourth adds another 7, the average will rise from 3 units each to 4 units each. If the extra worker makes fewer extra units the average will fall, e.g. three workers make 9 units in total(on average 3 each) and the fourth add only 1 unit, the average 10 divided by 4,i.e. 2.5 units each.
Marginal cost (MC) is the extra cost of producing another unit. The MC curve in the short run is inversely related to the MP-when the MP increases, the MC falls and vice versa. Imagine the variable factor is labour. When the extra worker is more productive, less of their time is needed to make an extra unit. Assuming wages are constant, this means the extra cost of a unit will fall. When each extra worker is less productive, more of their time will be needed to make an extra unit and so the marginal cost of the unit will rise.
Diminishing returns is as additional units of a variable factor(such as labour) are added to a fixed factor(such as capital), the extra output of the variable factor will eventually diminish. The ‘Nike’ shape of MC is a reflection of the law of diminishing returns.
Average product (AP) is the average output per unit of the variable factor, i.e. the productivity of the...
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