Question

Diminishing returns occur _________

• A. when units of a variable input are added to a fixed input and total product falls
• B. when units of a variable input are added to a fixed input and marginal product falls
• C. when the size of the plant is increased in the long run
• D. when quantity of the fixed input is increased and returns to the variable input falls

Answer 1

The correct option is B when units of a variable input are added to a fixed input and marginal product falls

The U shape of the AVC curve follows directly from the law of variable proportions. Initially there is too little of a variable input in comparison to the fixed input resulting in the under utilization of the fixed input. Thus as the quantity of variable input is initially increased, the fixed input is being better utilized, resulting in an increase in efficiency and thus the AVC initially falls due to increasing marginal product. However as more variable input is added beyond a point this leads to overcrowding and inefficiencies and thus it leads to falling marginal productivity which leads to rising AVC.