Question

b. Explain the relationship between total product, marginal product, and average product. [3 marks]

c. What is the law of diminishing returns and what does it explain the shape of the short run average cost curve. [3 marks]

d. Why is the level of output at which marginal revenue equals marginal cost the profit maximizing output?

Answer 1

b. Explain the relationship between total product, marginal product, and average product

The marginal product and average product curves initially increase then decrease due to the law of diminishing marginal returns.

Marginal product is the change in total product divided by the change in quantity of resources (or inputs).

Average product is the total product divided by the quantity of economic resources (or inputs).

A mathematical connection between average product and marginal product stating that the change in the average product depends on a comparison between the average product and marginal product. If marginal product is less than average product, then average product declines. If marginal product is greater than average product, then average product rises. If marginal product is equal to average product, then average product does not change.

The relation between average product and marginal product is one of several that reflect the general relation between a marginal and the corresponding average. The general relation is this:

If the marginal is less than the average, then the average declines.
If the marginal is greater than the average, then the average rises.
If the marginal is equal to the average, then the average does not change.

This general relation surfaces throughout the study of economics. It also applies to average and marginal cost, average and marginal revenue, average and marginal propensity to consume, and well, any other average and marginal encountered in economics.

c. What is the law of diminishing returns and what does it explain the shape of the short run average cost curve

A concept in economics that if one factor of production (number of workers, for example) is increased while other factors (machines and workspace, for example) are held constant, the output per unit of the variable factor will eventually diminish.
Although the marginal productivity of the workforce decreases as output increases, diminishing returns do not mean negative returns until (in this example) the number of workers exceeds the available machines or workspace. In everyday experience, this law is expressed as "the gain is not worth the pain."

The short run is a time period where at least one factor of production is in fixed supply. We normally assume that the quantity of plant and machinery is fixed and that production can be altered through changing variable inputs such as labour, raw materials and energy.

In the short run, the law of diminishing returns states that as we add more units of a variable input to fixed amounts of land and capital, the change in total output will at first rise and then fall. Diminishing returns to labour occurs when marginal product of labour starts to fall. This means that total output will be increasing at a decreasing rate.

The marginal cost of supplying an extra unit of output is linked with the marginal productivity of labour. The law of diminishing returns implies that marginal cost will rise as output increases. Eventually, rising marginal cost will lead to a rise in average total cost.

When diminishing returns set in the marginal cost curve starts to rise. Average total cost continues to fall until the point where the rise in average variable cost equates with the fall in average fixed cost. This is known as the output of productive efficiency

C, Why is the level of output at which marginal revenue equals marginal cost the profit maximizing output

Marginal Cost

Marginal cost is the change in the total cost that occurs when the quantity produced is increased by one unit. It is the cost of producing one more unit of a good. When more goods are produced, the marginal cost includes all additional costs required to produce the next unit. For example, if producing one more car requires the building of an additional factory, the marginal cost of producing the additional car includes all of the costs associated with building the new factory. Marginal cost is the change in total cost divided by the change in output.

An example of marginal cost is evident when the cost of making one pair of shoes is $30. The cost of making two pairs of shoes is $40. Therefore the marginal cost of the second shoe is $40 -$30=$10.

Marginal Revenue

Marginal revenue is the additional revenue that will be generated by increasing product sales by one unit. In a perfectly competitive market, the price of the product stays the same when another unit is produced. Marginal revenue is calculated by dividing the change in total revenue by the change in output quantity.

For example, if the price of a good in a perfectly competitive market is $20, the marginal revenue of selling one additional unit is $20.

Marginal Cost-Marginal Revenue Perspective

Profit maximization is the short run or long run process by which a firm determines the price and output level that will result in the largest profit. Firms will produce up until the point that marginal cost equals marginal revenue. This strategy is based on the fact that the total profit reaches its maximum point where marginal revenue equals marginal profit. This is the case because the firm will continue to produce until marginal profit is equal to zero, and marginal profit equals the marginal revenue (MR) minus the marginal cost (MC).