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Thursday, 4 August 2011

Word of the Day

Law of Diminishing Marginal Returns

States that when a variable factor of production is added to a fixed factor of production, the result will be an increase in marginal output. However after a certain point, the marginal returns will eventually start to fall. The law only operates in the SHORT RUN

When more and more labour (variable factor) is added to machinery and equipment (fixed factor), the marginal product of labour will fall because the workers are getting in each other's way. They are not any less hard working or motivated.
The LoDMR is also the reason why the AC curve falls and then increases.

Before point A, average costs fall as output increases because the addition of variable factors cause an increase in marginal output. Also, the average variable cost (AVC) curve falls slightly , accounting for the fall in average total costs.

After point A, AC rises due to the LoDMR because variable costs to rise.
Remember AC = AVC+AFC  therefore if AVC rises, AC rises. (AFC - average fixed cost)
The spreading of fixed costs become insufficient in the short run.

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