Describe how diminishing marginal returns affect a firm's average cost.

Diminishing marginal returns is a situation where the addition of one unit of a variable input increases output by less than the addition of the previous unit (i.e. declining marginal physical product). A delivery company with 5 vans and 5 workers can make 100 deliveries. The addition of a sixth worker may increase output to 120 deliveries as the sixth worker can make deliveries in the other workers' breaks. The addition of a seventh worker might only increase output to 125 deliveries as capital is a limiting factor (there is no van for the seventh worker to drive). The sixth worker has a MPP of 20 deliveries whilst the seventh has a MPP of 5 - diminishing marginal returns. If each driver is paid £100, we can see how this affects average cost. 5 workers each being paid £100 is £500, divided by 100 deliveries is £5 per delivery. 6 workers each being paid £100 is £600, divided by 120 is also £5. When diminishing marginal returns set in, 7 workers each being paid £100 is £700, divided by 125 deliveries is £5.60, increasing the average cost of production.