Question

*Explain clearly what is meant by the "law of diminishing returns".

*Explain clearly how diminishing returns affect the behavior of the average variable cost, as the production volume of good X increases?

*Supply (in pure competition) is determined by a point in the ascending segment of marginal cost. True False? Explain carefully.

Answer 1

1 - The law of diminshing returns states that as more and more inputs are added to the production process , the marginal output derived from each unit of input added will go on decreasing.

2 - At the initial phase of production , increasing returns are there and hence the AVC is falling till it reaches the minimum point. After some point in the production , the inputs start giving the diminshing return. More inputs result in the lesser output and hence the AVC starts to rise. This gives the U shape to the AVC curve

3 - True

The supply curve of competitve firm is the region between AVC and MC where MC is above AVC. MC is above AVC only when MC is rising. So the given statement is correct