Stages of Production | Sahithyan's Notes

Production can be divided into three stages based on the relationship between Total Product (TP), Average Product (AP), and Marginal Product (MP).

Stage 1

MP > AP

AP is rising.
MP is greater than AP.
TP is increasing.

Stage 2

0 < MP < AP

MP is positive.
MP is lower than AP.
TP continues to increase.
This is the economically relevant stage of production.

Stage 3

MP < 0

MP is negative.
TP decreases.
Additional units of the variable input reduce total output.

The three stages of production are determined by the relationship between MP and AP. Stage 2 is the economically relevant stage because MP is positive but below AP.

Law of Diminishing Marginal Returns

The Law of Diminishing Marginal Returns states that the marginal product of the variable input will eventually decline as more units of the variable input are added while the fixed input remains constant.

There is a limit to the output that can be produced in a productive facility of a given size and technology.

Key Point

As more units of the variable input are added to a fixed input:

MP \text{ eventually decreases}

This is a short-run concept because at least one input is fixed.

Marginal Revenue Product

Marginal Revenue Product (MRP) is the additional revenue generated by using one more unit of an input.

For labour:

MRP_L = MP_L \times P

Where:

MRP_L = Marginal Revenue Product of Labour
MP_L = Marginal Product of Labour
P = Price of output

Marginal Resource Cost

Marginal Resource Cost (MRC) is the additional cost of using one more unit of a resource.

For labour:

MRC_L = Wage

Optimal Use of Labour

A firm should increase its use of labour when the additional revenue generated is greater than the additional cost.

The optimal level occurs when:

MRP_L = MRC_L

Therefore:

MRP > MRC → increase labour.
MRP < MRC → decrease labour.
MRP = MRC → optimal level of labour.

The firm's optimal use of labour occurs where MRP = MRC.

Diminishing Returns and Cost

Diminishing marginal product means each added unit of the variable input adds less output. The cost of each extra unit of output, $MC$ , therefore rises.

As output expands, the total cost curve becomes steeper.

Worked Examples

Marginal Product Under Diminishing Returns

What happens to $MP_L$ under diminishing marginal returns?

Solution Reveal Hide

$MP_L$ decreases. Each extra worker adds less than the previous one because the fixed inputs are spread thinner.

$MP_L$ stays positive until total output actually falls.

Shape of the Total Cost Curve

True or false. Because of diminishing marginal product, the total cost curve becomes flatter as output expands.

Solution Reveal Hide

False.

Diminishing marginal product means rising marginal cost, so the total cost curve becomes steeper.