Explanation of inverse relationship between MP and MC.docx

# Explanation of inverse relationship between MP and MC.docx...

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Example to demonstrate the inverse relationship between marginal product (MP) and marginal cost (MC) Consider the following information of a firm operating in the short run. Suppose the labour cost is \$200 per day, and the firm has fixed costs of \$1,000 per day. Workers Output Marginal product Total cost (\$) Average total cost (\$) Marginal cost (\$) 0 0 - 1,000 - - 1 20 20 1,200 60.00 10 2 50 30 1,400 28.00 6.67 3 90 40 1,600 17.78 5 4 120 30 1,800 15.00 6.67 5 140 20 2,000 14.29 10 6 150 10 2,200 14.67 20 7 155 5 2,400 15.48 40 Given the presence of fixed inputs, the law of diminishing returns demonstrates that when more workers (variable inputs) are added to the production process at the beginning, MP increases, however, when more and more workers are added (in this case when the number of workers exceeds 3), MP starts to decrease. When the number of workers increases from 0 to 1, MP (calculated as ∆TP / ∆L) of the additional worker is 20. The labour cost for this additional unit of worker is \$200. The MC (calculated as ∆TC / ∆Q) is calculated as \$200/20 = \$10. When the number of workers increases from 1 to 2, MP of the additional worker is now increased

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