In the last section we looked at the law of diminishing marginal returns, total physical product (TPP) and marginal physical product (MPP). We found out that as the units of a variable factor were added to the other fixed factors, the marginal physical product rose then diminished, and eventually became negative. Average physical production rose and diminished too. We graphed these functions, but it would now be tedious to use actual numbers every time so usually we sketch these curves. The MPP and APP curves are exaggerated in order to make the principle clearer.

What the model is saying is that when few workers are employed they are not very productive. As the number of workers increases their productivity rises, and then after a certain point productivity diminishes. It would seem a simple matter of deduction to see that this is the same as saying that when a few workers are employed and they are relatively unproductive this is expensive (unit costs are high) and when they are more workers they are more productive and unit costs are low. As more workers are employed they eventually become less productive and average costs start to rise again.

Let us use the numbers from the previous exercise to help calculate the costs of production. We will assume that fixed costs, the rent of land, machinery and buildings comes to £1,000 and that variable costs are the labour and each person is paid £3000.


Marginal cost - The change in total cost when one more unit of output is produced. MC = TC/△Q

Total variable cost is the variable cost multiplied by the level of output. TVC = VC x Q.

Average variable cost is the total variable cost divided by the level of output. AVC + TVC/Q.

Average fixed cost is the fixed cost divided by the level of output. AFC = FC/Q.

Total cost is the total fixed cost plus the total variable cost. TC = FC + TVC.

Average cost or unit cost is the equal to the total cost divided by the level of output. AC = TC/Q or AVC + AFC.

Quiz - This is a tricky test on costs. Useful for a homework or class test. For answers email me by clicking on the contact link below. Write COST QUIZ in the subject heading.

Costs test