Question

Explain how it is possible for a firm to experience simultaneously an increasing average product but a diminishing marginal product.

Short answer

A firm can have an increasing average product and a diminishing marginal product if each additional unit of input, though less impactful than the previous, still sufficiently raises the overall output average.

Step-by-step solution

Understanding Key Concepts

Begin by defining the key terms: Average Product (AP) and Marginal Product (MP). The Average Product is the total product divided by the quantity of input. The Marginal Product is the additional output from one more unit of input.

Analyze Marginal Product Behavior

A diminishing marginal product indicates that with each additional unit of input, the increase in output is smaller. This usually happens when one factor of production is fixed, leading to decreased efficiency as more units are added.

Analyze Average Product Behavior

Increasing average product means the ratio of total output to input is rising. This suggests that the efficiency of input use is improving overall, possibly due to factors like better coordination or learning effects.

Combine Both Concepts

Despite a diminishing marginal product, the average product can still be increasing if the marginal product, despite shrinking, is still above the current average product. This effectively raises the average.

Example Calculation

Consider a set of input-output values where the output continually increases, but the rate of increase (MP) decreases. For example, if the fifth worker adds 9 units while the fourth added 11, that’s diminishing MP. However, if the total product is high enough, adding any positive MP can still raise the average product.

Key concepts

Average Product

The Average Product (AP) measures the efficiency of input use by showing the average amount of output produced per unit of input. To calculate it, you divide the total output (Total Product, TP) by the quantity of input used. For example, if a factory produces 100 units of goods using 10 workers, the average product per worker is 10 units. This calculation helps firms understand how well they are utilizing their resources. If the AP is increasing, it suggests that each worker, on average, is producing more over time, which can happen due to reasons like improved skills or better technology.

Marginal Product

Marginal Product (MP) measures the additional output that results from using one more unit of input while keeping other inputs constant. For instance, if adding an extra worker increases the total output from 100 to 120 units, the MP of this worker is 20 units. This metric helps in deciding how many additional units of input should be employed. As firms add more units of input, they often encounter diminishing marginal returns, where each new unit of input contributes less to the overall output compared to the previous unit. This is common in real-world production where resources like space or equipment may become saturated.

Diminishing Marginal Returns

Diminishing Marginal Returns occur when each additional unit of input contributes less to the total output than the previous unit. This concept typically arises when one factor of production is fixed. For example, in a factory with a limited number of machines, hiring more workers will initially increase production but eventually lead to overcrowding and inefficiencies. Understanding diminishing returns is crucial for firms to optimize their level of production. Firms need to identify the point at which adding more inputs becomes inefficient and costs outweigh the benefits.

Production Efficiency

Production Efficiency is achieved when a firm produces the maximum possible output with the given set of inputs or produces a given level of output using the minimum amount of inputs. Firms aim to achieve higher efficiency to reduce costs and increase profitability. This can be attained through various means such as improving worker training, investing in better technology, and refining production processes. Monitoring metrics like Average Product and Marginal Product helps firms make informed decisions to adjust their input levels and improve overall production efficiency.