Explain how a firm's costs of production are affected by the law of diminishing marginal returns in the short run (10)
The law of diminishing marginal returns is when a firm experiences a fall in returns as more units are produced in the short term.
In the short run at at least one factor is fixed, such as land or capital,and as such they cannot be expanded to meet supply in the short run. Therefore in order to increase its productive output a firm will hire more labour. This allows the firm to reduce its short term average costs, as shown on diagram one with a movement from q1 to q2 and a movement from p1 to p2, an increase of quantity output and a fall in costs per unit.
However after a certain amount of workers are employed a certain ‘too many cooks spoil the broth’ effect occurs, by which I mean that as more people are employed the is more crowding in factories and the likelihood of mistakes increases. As a result the the average costs increase as shown on the short run average cost curve above with a shift from q2 to q3 and a resultant movement from p2 to p3.
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