Law of Diminishing Returns, Marginal Cost and Average Variable Cost
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Last updated 7 Apr 2019
In this short revision video we go through the law of diminishing returns and explain the link between declining marginal productivity and rising short run marginal and average variable cost.
Diminishing returns to labour in the short run
As more of a variable factor (e.g. labour) is added to a fixed factor (e.g. capital), a firm will reach a point where it has a disproportionate quantity of labour to capital and so the marginal product of labour will fall, thus raising marginal cost and average variable cost.
The law of diminishing marginal returns states that employing an additional factor of production will eventually cause a relatively smaller increase in output. This occurs only in the short run when at least one factor of production is fixed (e.g. capital) and so increasing a variable factor (e.g. labour) will result in the extra workers getting in each other’s way, reducing productivity. Hence the short run cost curve at first falls as increasing marginal returns are enjoyed (from specialisation and division of labour) but then there comes a point when the increased variable factor results in rising costs because productivity is hampered.