1

THEORY OF THE FIRM6.1 THE LAW OF DIMINISHING RETURNS

2

HOW MUCH TO PRODUCE?

Feed the world from crops grown in a flower pot!

Not possible!! Why?

The Law of Diminishing Returns

Says that the addition of extra units of a variable factor of production will at first cause an increase in output, but as fixed factors of production become fully employed output per unit of the variable factor will eventually begin to fall.

3

TRY IT: PAPER RING FACTORY

Resources: Paper, Scissors, Ruler and Tape

Process: Cut the paper into strips as demonstrated and tape the ends together

Constraints:

• Only one pair of scissors, one ruler and one tape dispenser are available

• Paper is unlimited

• Workers must remain in the factory (keep in contact with the desk)

Observers: Complete the table with observations of each round

3

6

12

14

15

13

12

10

6

0 1 2 3 4 5 6 7 8Units of Input (Workers)

0 1 2 3 4 5 6 7 8Units of Input (Workers)

Plot of Total Product

Plot of Marginal and Average Product

Uni

ts o

f O

utpu

tU

nits

of

Out

put

36

12

1415

13

12

10 TP

3

6

12

14

15

13

12

10

3

6

2

1

-2

-1

-2

Marginal Product is the change in Total Product created by the addition of one more unit of the Variable Factor of Production: here, Labour

8

0 1 2 3 4 5 6 7 8Units of Input (Workers)

0 1 2 3 4 5 6 7 8Units of Input (Workers)

Plot of Total Product

Plot of Marginal and Average Product

Uni

ts o

f O

utpu

tU

nits

of

Out

put

36

12

1415

13

12

10 TP

3

6 6

2

1

-1-2 MP

3

6

12

14

15

13

12

10

3

6

2

1

-2

-1

-2

3

3

4

3.5

3

2.1

1.7

1.25

Average Product is, well, the average! Total Product/Units of Input

10

0 1 2 3 4 5 6 7 8Units of Input (Workers)

0 1 2 3 4 5 6 7 8Units of Input (Workers)

Plot of Total Product

Plot of Marginal and Average Product

Uni

ts o

f O

utpu

tU

nits

of

Out

put

36

12

1415

13

12

10 TP

3

6 6

2

1

-1-2 MP

33 34 3.5 3

2.11.7 1.25 AP

11

ECONOMICS CLASSROOM RESOURCE

http://www.econclassroom.com/?p=2969

Task 1: Create a Total Product table in your notebook and copy the TP data from the video into the table. Calculate marginal and average product.

Plot the Total Product, Marginal Product and Average Product data. (# of units input vs. # units of output). (See the previous slides and the example in the video.)

Explain the shape of the three curves. (What is happening as we add more and more workers to the factory production process?)

Task 2: Answer the Test Your Understanding questions (TYU 6.1) on page 143-144. You SHOULD be able to explain the Law of Diminishing Returns to someone who hasn’t heard of it before.

12

ASSESSMENT

With a partner, go to the white board and illustrate the Law of Diminishing Returns. Explain the curves to your partner.

(Hint: Tell the epic Paper Ring Factory story to your audience and illustrate what happened using the table and curves.)

NEXT: Distinguishing the Short Run timeframe from the Long Run timeframe in Theory of the Firm Lesson 2