economic question

Question

With a typical production function, diminishing returns occurs ____________ the diminishing average product is reached.

1. A. after
2. B. before
3. C. at the same point
4. D. none of the above

Answer 1

The correct answer is... diminishing returns occurs before the diminishing average product is reached.

The question asks about diminishing average product. This is the point in which average product has reached it's maximum peak and is now decreasing. Imagine an upside-down U-curve with input on the x-axis and output on the y-axis. Diminishing average product is on the right-side of this curve.

Diminishing returns refers to when the marginal product has reached it's peak and is now decreasing. Similar to the average product, it is an inverted U-curve and is the right side of the graph.

When does diminishing returns occur relative to diminishing average product? In other words,

when does the marginal product have a negative slope, compared to when the average product has a negative slope?

I like to use a student's GPA (grade point average) as an analogy when I explain this concept in class.

Your grade for a particular class is the marginal product. Your GPA is the average product. Imagine your grade for a class is an A (4.0 grade points) and your GPA is 2.0. What will happen to your grade point average?

It will go up.

Now suppose your grade for this class is a C (2.0 grade points) and your GPA is 3.0. What will happen to your GPA?

It will go down.

In other words, if your score for your class is BELOW your GPA, it will bring your GPA down. If your score for a class is ABOVE your GPA, it will bring your GPA up.

Putting this in terms for the firm: When the marginal product is above the average product, the average product is increasing. When the marginal product is below the average product, the average product is decreasing.

Suppose you receive a A (4.0 grade points) in this class and have a 2.0 GPA. What happens to your GPA? It will go up. Your GPA now updates to 2.5.

Suppose you have reached "diminishing marginal product" and now receive a lower grade in your next class, a B (3.0 grade points).

This will still cause your GPA to go up (since 3 is larger than 2.5), but not as much as receiving the previous `A'. This is because the returns are diminishing, moving from a class grade of 4.0 to 3.0.

In this region of the graph, your average total product is still increasing (exhibiting positive slope) and has not reached it's maximum. However, we have reached diminishing marginal product. Therefore, you know that diminishing marginal returns must occur before diminishing average product.