AP Microeconomics: Short-Run Production Costs
Diminishing Marginal Returns
More Cooks, More Problems
In the short run, a business operates with a mix of fixed and variable inputs. A fixed input is something that can't be changed quickly, like the size of a factory or the number of ovens in a bakery. A , on the other hand, can be adjusted easily. The most common example is labor. You can ask workers to stay for an extra shift or hire new staff relatively quickly.
Let's stick with the bakery. Imagine a small shop with one big oven. This oven is the fixed input. The owner wants to produce more bread, so she starts hiring bakers, the variable input. The total amount of bread they produce is the Total Product (TP).
At first, adding a second baker more than doubles the output. They can specialize: one baker mixes dough while the other manages the oven. But what happens as more bakers are hired? The kitchen gets crowded. They start bumping into each other. They have to wait to use the single oven. The contribution of each new baker starts to fall.
Measuring the Margin
To analyze this effect, economists use Marginal Product (MP). This is the extra output produced by adding one more unit of a variable input, in this case, one more baker. It’s the change in Total Product.
Another useful measure is Average Product (AP), which is simply the total output divided by the number of inputs.
Let's see how these numbers look for our bakery.
| Bakers (L) | Total Product (TP) | Marginal Product (MP) | Average Product (AP) |
|---|---|---|---|
| 0 | 0 | - | - |
| 1 | 10 | 10 | 10.0 |
| 2 | 25 | 15 | 12.5 |
| 3 | 45 | 20 | 15.0 |
| 4 | 60 | 15 | 15.0 |
| 5 | 70 | 10 | 14.0 |
| 6 | 75 | 5 | 12.5 |
| 7 | 75 | 0 | 10.7 |
| 8 | 72 | -3 | 9.0 |
Notice that Marginal Product first increases (from 10 to 20) as the first few bakers work more efficiently together. Then it starts to fall. This is the Law of Diminishing Marginal Returns in action: as you add more of a variable input to a fixed input, the marginal product of the variable input will eventually decline.
This isn't a theory; it's a physical reality. Too many cooks spoil the broth, and too many bakers crowd the oven.
Eventually, MP becomes zero (the 7th baker adds no extra output) and then negative (the 8th baker gets in the way, and total output actually falls).
The MP and AP Relationship
The Marginal Product and Average Product curves have a specific relationship that is important to understand. When you plot them, you can see this interaction clearly.
Think of it like your grade point average. If your score on the next test (your marginal grade) is higher than your current GPA (your average grade), your GPA will go up. If your next test score is lower than your GPA, your GPA will go down.
It's the same with production:
- When Marginal Product is above Average Product, AP is rising.
- When Marginal Product is below Average Product, AP is falling.
- Therefore, the MP curve must intersect the AP curve at its highest point.
This relationship isn't just a mathematical curiosity. The shape of the MP curve is a mirror image of the Marginal Cost curve, a key concept for understanding how firms decide how much to produce. As productivity falls, costs rise. But that's a story for next time.
Ready to test your understanding?
In the short run, what is a defining characteristic of a 'variable input'?
A pizza parlor has one large pizza oven. As they hire more cooks, the kitchen gets crowded and cooks have to wait to use the oven, leading to each additional cook adding less to the total number of pizzas made. This situation is a direct example of what economic principle?
Understanding diminishing returns is the first step to analyzing a firm's costs and, ultimately, its behavior in the market.