This document discusses the concepts of short run and long run costs, diminishing marginal returns, and the relationship between total, marginal, and average product. In the short run, average costs rise due to diminishing marginal returns, where adding more of a variable input to a fixed input results in lower marginal productivity. In the long run, all inputs are variable and diminishing returns can be avoided by adjusting all factors of production. The marginal product of an input initially rises with addition of units, due to specialization effects, but eventually declines as the fixed inputs become overloaded, illustrated with a total, marginal, and average product curve analysis. Diminishing returns refers to an increasing total product at a decreasing rate.

1. Costs in the Long Run

2. Review Questions
• Why, in the short-run,
does the Average cost
curve turn upwards?
• It is pulled up by
increasing Marginal
Costs, which are
increasing due to
Diminishing Marginal
Returns.

3. Review Questions
• Why does the marginal
cost curve initially go
down, before it
encounters diminishing
returns?
• Because of
‘Specialisation’ and the
division of labour.

4. Learning Goals
• Explain the difference between the short and
long-run.
• Use the concept of marginal returns to explain
the various stages of the law of diminishing
returns.
• Explain that diminishing returns has set in
when output is rising, but at a falling rate.

5. Types of Factors
• Variable Factors
•  or  as output
changes
• can be changed in
the short run
• e.g. labour, raw
materials
• Fixed Factors
• Cannot be changed
in the short run
• Needed even if
output is zero
• e.g. building,
machinery
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6. Time Periods
Short Run
–Time too short to
change fixed
factors.
–Enough time to
change some
variable factors.
–Firm can use
existing fixed
factors more
intensely.
Long Run
–Enough time to
change all inputs.
–No fixed factors.
–All factors are
variable.
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7. Law of Diminishing Returns
• As additional inputs are added to a fixed
input, the Marginal Product (MP) may at first
increase but will eventually decrease.
• They will be limited by the fixed (capital/land).
After a time, the addition of variable
inputs makes less and less difference to
total output .
• Occurs in the short run.
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8. Total and Marginal Product
8
Total Marginal Average
Labour product product product
(workers (T-shirts (T-shirts per (T-shirts
per day) per day) worker) per worker)
B 1 4 4.00
C 2 10 5.00
D 3 13 4.33
E 4 15 3.75
F 5 16 3.20
4
6
3
2
1

9. Total Product (TP)
• Total output obtained by combining all the
factors in the production process
• TP rises, reaches a maximum then declines
9

10. Total Product Curve
10
0 1 2 3 4 5
Labour (workers per day)
5
10
15
TP
A
B
C
D
E
F
Output
(T-shirts
per
hour)

11. Marginal Product (MP)
• Extra output which is gained by using
one more unit of a factor to the fixed
factor
• MP =  TP
• MP rises , reaches a maximum
(before TP does) and then declines
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12. Marginal Product Curve
• Marginal product is also measured by the slope
of the Total Product curve
Law of diminishing returns
– As a firm uses more of a variable input, with a
given quantity of fixed inputs, the marginal
product of the variable input eventually
diminishes to zero.
(TP will be increasing at a decreasing rate and
would eventually turn negative)
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13. Marginal Product
13
Labour (workers per day)
C
TP
Output
(T-shirts
per
hour)
Labour (workers per day)
Marginal
product
(T-shirts
per
hour
per
worker)
MP
D
The red highlights
the point of
diminishing returns
0 1 2 3 4 5
10
15
4
13
16
0 1 2 3 4 5
2
4
3
6
E
F
B

14. Why Increasing Returns?
• At first the addition of variable inputs
allows specialisation and division of
labor.
• The MP may rise as additional variable
inputs are used in production.
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15. Why Diminishing Returns?
• Adding more variable factors causes
overcrowding of the fixed factor.
• MP begins to fall.
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16. Average Product (AP)
• The average product of each unit of
the variable factor
• AP = TP
units of Variable factor
• AP steadily rises , reaches a maximum
and then declines
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17. AP and MP
17
0 1 2 3 4 5
Labor (workers per day)
2
4
6
Average
product
&
Marginal
product
(T-shirts
per
day
per
worker)
4.33
MP
AP
Maximum
average
product
C
D
E
F
B

18. Average Product Curve
–When marginal product exceeds average
product, average product increases.
–When marginal product is below average
product, average product decreases.
–When marginal product equals average
product, average product is at its
maximum.
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19. AP = Productivity
• The efficiency involved in gaining
outputs (products) from inputs
(resources)
• Productivity = Output
Input
Per unit of time
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20. Law of Diminishing Returns
• Law of Diminishing Returns does not tell us
at what output level the firm should
produce – need to know the cost of each
variable input.
• But it does tell us that as long as MP , it
is worth increasing production and not
worth producing once MP = O or is
negative.
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21. The Relationships
• If TP and MP are increasing
• TP is increasing at an increasing rate
= INCREASING RETURNS
• if TP  , MP  then
• TP is increasing at a decreasing rate
= DIMINISHING RETURNS
• if MP is negative
• TP is falling
= NEGATIVE RETURNS
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