3. The Law of Diminishing Marginal
Returns and Marginal Cost
4. Marginal Physical Product and
Marginal Cost
• Marginal cost is a reflection of the marginal
physical product of the variable input.
• As the marginal physical product curve
rises, the marginal cost curve falls; and as
the marginal physical product curve falls,
the marginal cost curve rises.
• What the marginal cost curve looks like
depends on what the marginal physical
product curve looks like.
5. Average Productivity
• Average physical product
is output divided by the
quantity of labor.
• When the term labor
productivity is used in the
newspaper and in
government documents, it
refers to the average
physical productivity of
labor on an hourly basis.
6. Q & A
• If the short run is six months, does it follow that
the long run is longer than six months?
• “As we add more capital to more labor, eventually
the law of diminishing marginal returns will set
in.” What is wrong with this statement?
• Suppose a marginal cost (MC) curve falls when
output is in the range of 1 unit to 10 units, flattens
out and remains constant over an output range of
10 units to 20 units, and then rises over a range of
20 units to 30 units. What does this have to say
about the marginal physical product of the
variable input?
7. Costs of Production: Total, Average,
And Marginal
• The Average Fixed Cost (AFC) = Total fixed cost
divided by quantity of output
• The Average Variable Cost (AVC) = Total
variable cost divided by quantity of output.
• The Average Total Cost (ATC) or Unit Cost=
Total Cost divided by quantity of output.
• The Marginal Cost is the change in total cost or
total variable cost that results from a change in
output
10. The Average-Marginal Rule
When the marginal
magnitude is above the
average magnitude,
the average magnitude
rises; when the
marginal magnitude is
below the average
magnitude, the
average magnitude
falls.
12. Tying Short-Run Production To Costs
• Production underlies what
many of the various cost
curves looks like.
• What happens in terms of
production affects
Marginal Cost, which in
turn eventually effects
Average Variable Cost
and Average Total Cost.
14. Sunk Cost
Sunk cost is a
cost incurred in
the past that
cannot be
changed by
current decisions
and therefore
cannot be
recovered.
15. Q & A
• Identify two ways to compute average total cost
(ATC).
• Would a business ever sell its product for less than
cost? Explain your answer. (Hint: Think of sunk
cost)
• What happens to unit costs as marginal costs rise?
Explain your answer.
• Do changes in marginal physical productivity
influence unit costs? Explain your answer.
16. Long – Run Average Total Cost Curve
• Long Run Average Total Cost Curve shows
the lowest unit cost at which the firm can
produce any given level of output.
17. Economies of Scale, Diseconomies of
Scale, and Constant Returns to Scale
• Economies of Scale exist when inputs are increased by
some percentage and output increases by a greater
percentage, causing unit costs to fall.
• Constant Returns to Scale exist when inputs are increased
by some percentage and output increases by an equal
percentage, causing unit costs to remain constant.
• Diseconomies of Scale exist when inputs are increased by
some percentage and output increases by a smaller
percentage, causing unit costs to rise.
• Minimum Efficient Scale is the lowest output level at
which average total costs are minimized.
