Short-run Productivity, Costs and the Law of Diminishing Marginal Returns

In the last lesson it was shown how the law of diminishing marginal returns affects the productivity of labor as a firm varies the number of workers employed towards the production of its output in the short-run. Due to the fact that capital and land are fixed in quantity, the addition of more workers to a factory will ultimately lead to the marginal product of labor declining, and even becoming negative if too many workers try to squeeze into a limited amount of space and work with a fixed number of tools.

The most significant implication of the law of diminishing marginal returns for a producer is the effect it has on a firm’s costs of production in the short-run. A firm’s variable costs are determined by the productivity of labor, since labor is the primary variable resource. When worker productivity is rising, a firm’s costs are falling; but when the firm begins experiencing diminishing marginal returns, productivity fall and the cost of additional units of output begins to rise.

This lesson illustrates using data and graphs the relationship between productivity and costs in the short-run, and how the law of diminishing marginal returns determines the shapes of the short-run cost curves: marginal cost and average variable cost.


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