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This a fundamental for theory of the firm. It explains the shape of the marginal product (MP) curve!
Formal Definition: When one or more factors are held fixed, there will come a point beyond which the extra output from additional units of the variable factor will diminish.
Note the underlying assumptions are:
1)at least one factor is fixed 2) each unit of the variable factor is the same(each worker is equally trained) 3)the level of technology is held constant.
How to think of it: So at first, adding new workers(variable factor) to a factory will increase output significantly as they can use up free capital and specialize. However, these gains diminish as even more labour is added as the fixed amount of capital becomes over utilised. Workers get in each others way, two or more people doing one job as there is not enough space or capital which means output increases yet at a slower rate(diminishes).
How to remember it:
The graph is your new bestfriend!
Things to consider:
1) This rule only holds in the short run, as in the long run all factors of production are variable. e.g. the firm can move to a bigger factory, buy more machinery.
2) Don't confuse diminishing returns and diseconomies of scale! Although similar in principle, diminishing returns refers to production and output levels in the short run, while diseconomies of scale looks at rising costs over the long run!
3) It can go negative! When the marginal product of the variable factor is negative a unit increase in the variable product causes total output to fall. e.g. adding more workers hinders the efficiency of exsiting workers causing actual output to fall.
Other topics it links to:
Diminishing marginal utility- as more units of a good are consumed, additional units will provide less additional satisafation than previous units. < This comes under the topic of indifference curves, may not be on ALL alevel syllabus'.see more