Question

If you owned a business and labour is the only variable input, explain:

a) using numerical examples, how decreasing marginal product of labour will affect your marginal returns and marginal cost.   2 Marks

b) how a change in marginal cost can affect your average total cost and your profit.  

Answer 1

a) Assume labor is the only input and one labor cost you $10 per hour. You can see from the below table as labor rises, total product rises while marginal prooduct starts falling (Diminishing marginal return of labor) with constant marginal cost of hiring labor.

Labor	Cost	Marginal Cost	Total Product	Marginal Product
1	10	-	10	-
2	20	10	20	10
3	30	10	29	9
4	40	10	37	8
5	50	10	44	7
6	60	10	50	6
7	70	10	55	5
8	80	10	59	4
9	90	10	63	4
10	100	10	66	3

b) Profit maximizes when marginal cost = marginal revenue. If marginal cost rises, producer will produce at a point where output produced is less than social optimum output and reduce overall profit level. On the other hand, if marginal cost falls, producer will produce more of the goods which maximizes profit level and raise overall profit.

As average total cost = total cost / output

If Marginal cost rises, gap between two consecutive total cost will rise which will raise average total cost.

Labor	Cost	Marginal Cost	Total Product	Marginal Product	Average Total Cost	Cost	Marginal Cost	Average Total Cost
1	10	-	10	-	10	20	-	20
2	20	10	20	10	10	40	20	20
3	30	10	29	9	10	60	20	20
4	40	10	37	8	10	80	20	20
5	50	10	44	7	10	100	20	20
6	60	10	50	6	10	120	20	20
7	70	10	55	5	10	140	20	20
8	80	10	59	4	10	160	20	20
9	90	10	63	4	10	180	20	20
10	100	10	66	3	10	200	20	20