Unit 3 Micro: Revision on the Law of Diminishing Returns

Why does the law of diminishing returns imply that average total cost is “U-shaped” in the short run?

The law of diminishing returns refers to the short run production function - where there is at least one fixed factor input.

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.

What might cause marginal product to fall? One explanation is that, beyond a certain point, new workers will not have as much capital equipment to work with so it becomes diluted among a larger workforce. A numerical example of diminishing returns is shown below

When marginal product starts to fall, it becomes more expensive to produce an additional unit of output and so marginal cost and average variable cost (AVC) eventually starts to rise.

Eventually the rise in average variable cost exceeds any fall in average fixed cost from a rise in production. There comes a point when average total cost starts to rise as well.

If a marginal cost is below average cost then average must be falling. Even if MC is rising, AC falls if MC