How does the law of diminishing returns affect short-run costs?

The law of diminishing returns states that as more units of a variable input are added to a fixed input, the marginal product of the variable input will eventually decrease. In the short run, where at least one input is fixed, this law has a direct impact on costs.

In the short run, a firm can adjust its variable inputs, such as labor or raw materials, but it cannot change its fixed inputs, such as capital or land. As the firm increases the quantity of the variable input, initially, the total product and marginal product of the variable input will increase. This means that each additional unit of the variable input contributes more to the total output.

However, as the law of diminishing returns sets in, the marginal product of the variable input will start to decline. This means that each additional unit of the variable input contributes less to the total output. As a result, the firm experiences diminishing returns to scale.

The impact of diminishing returns on short-run costs can be understood through the concept of marginal cost. Marginal cost is the additional cost incurred by producing one more unit of output. In the short run, as the law of diminishing returns takes effect, the marginal cost of production increases.

Initially, when the firm is operating in the region of increasing marginal returns, the marginal cost is decreasing. This is because the additional units of the variable input are more productive, leading to a decrease in the average cost of production. However, as diminishing returns set in, the marginal cost starts to rise. This is because the additional units of the variable input are becoming less productive, leading to an increase in the average cost of production.

Therefore, the law of diminishing returns affects short-run costs by causing the marginal cost of production to increase. This implies that as a firm increases its production in the short run, it will face higher costs per unit of output due to diminishing returns. This has important implications for decision-making, as firms need to carefully consider the trade-off between increasing production and the associated increase in costs.