Explain How the Law of Diminishing Returns and Returns to Scale Affect a Firm's Cost of Production (20 Marks)

Topics: Economics of production, Economics, Returns to scale Pages: 2 (697 words) Published: November 7, 2010
Explain how the law of diminishing returns and returns to scale affect a firm’s cost of production (20 Marks) The law of diminishing returns exist when increasing quantities of a variable input are combined with a fixed input, which eventually leads to the marginal product and the average product of that variable input will decline. Diminishing returns can affect a firms cost of production negatively in the short run. An example of this is that a business had 2 factors of production; Capital, which is fixed, and labour, which is variable. As output increases and is meet by an equal level of labour producing that output, meaning that labour is being productively efficient. However, as the level of labour keeps increasing more is being produced but the output per worker will have gone down from the optimum level, meaning that cost of production has increased but per unit of worker is not as efficient as it once was. This can be shown with the date in the table below. When 5 labour is employed the average of 39 units per worker, the highest it reached. After 5 units per worker the marginal product per worker starts to decrease in between 4 and 5 labour, showing that the output each worker is adding is decreasing, so the business is not gaining as much as it should be. The Marginal Product between 7 and 8 is -17, showing that the extra labour is costing the business output, which is going to have a huge negative effect to the cost of the firms’ production. Capital| Labour| Marginal| Total| Average|

10| 0| | 0| 0|
10| 1| | 20| 20|
10| 2| | 54| 27|
100| 3| | 100| 33|
10| 4| | 151| 38|
10| 5| | 197| 39|
10| 6| | 230| 28|
10| 7| | 251| 36|
10| 8| | 234| 29|

Reasons for the change in Average output per unit going down the more labour employed is due to such things like ‘too many cocks spoil a broth’, meaning that people will get in each other’s way and making it harder to work. Also the business won’t...
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