3. Law of Diminishing Marginal Returns (DMR)

What does 'law of diminishing marginal returns' mean?

Falling addictional returns.

When do diminishing marginal returns occur?

In the short run.

Define 'short run'.

A period of time when there is at least one fixed factor of production.

What is a fixed factor of production?

A factor input where its quantity cannot be altered in the short run. e.g. land.

What is a variable factor of production?

A factor input which can be altered in the short run. e.g. labour.

What does the law of diminishing marginal returns state?

In the short run, as variable factors of production are added to fixed factors of production, total/ marginal product will initially rise and then fall.

How do you calculate total costs?

Variable costs + fixed costs

Define variable costs. Give an example.

Costs which vary with output.

e.g. the cost of materials.

Define fixed costs. Give an example.

Costs which stay the same as output changes.

e.g. rent, bank loans.

Draw a diminishing marginal returns diagram.

Output - marginal product /_

Factor of production

(no of workers)

- Specialisation

- DMR

Explain what happens to output during diminishing marginal returns.

1. Specialisation - New workers learn from previous ones, specialising in job and splitting tasks between themselves, increasing output quickly.

2. Diminishing marginal returns - Labour productivity falls, not enough fixed factors of production, not enough room etc. Output falls.

How do you calculate average total costs? (ATC)

Total costs/ output

How do you calculate average fixed costs? (AFC)

Total fixed costs/ output

How do you calculate average variable costs? (AVC)

Total variable costs/ output

How do you calculate marginal costs?

Change in total costs/ change in output

How do you calculate marginal output.

change in total output/ change in quantity (of workers).

How do you calculate average output.

total product/ quantity (of workers)

How do you calculate marginal costs.

change in total costs / change in output.

Define marginal costs.

The additional costs of making one unit of extra output.

Draw a short run average cost curve.

Average costs fall as output rises quickly, then rise again. (specialisation vs diminishing marginal returns)

Draw a cost and revenue curve.

How do you calculate profit on a cost and revenue curve?

Draw a vertical line between average revenue and average total costs.

Calculate area of rectangle.

What is the profit maximising quantity (QPM) on a cost and revenue curve?

Where marginal costs = marginal revenue

MR = MC

Overall, explain what happens when firms overcome diminishing marginal returns.

1. Firms need more factors of production as they're limited by marginal costs rising.

2. Factors become variable overtime, meaning firm has left the short run.

3. In the long run, firms can move on to a series of new average costs.

4. Firm grows, gaining economies of scale in long run.