(a) State the law of diminishing return (b) What is (i) marginal product (ii) average product? (c) Explain any three factors that determine the size of firm...

Answer Details

(a) Law of diminishing returns. The law states that as more and more units of a variable factor (for example labour) are added to a fixed factor (for example land), a point is reached beyond which the extra (marginal) output from each additional unit of the variable factor begins to fall, other things being equal. It is also called the law of variable proportions.

(b) Definitions.

• (i) Marginal product. The addition to total output resulting from employing one more unit of the variable factor: \( MP = TP_n - TP_{n-1} \).
• (ii) Average product. Total output divided by the number of units of the variable factor employed: \( AP = \dfrac{TP}{L} \).

(c) Three factors that determine the size of firms.

1. Availability of capital. Firms that can raise large amounts of capital (for example through the sale of shares or bank loans) can expand to a large size, while those with limited finance remain small.
2. Size of the market. A large demand for the firm's product allows large-scale production, whereas a small or localised market keeps the firm small.
3. Nature of the product and technology. Goods that need heavy machinery and mass production (for example cars, cement) favour large firms, while goods requiring personal skill or catering to varied tastes (for example tailoring, catering) favour small firms. (Other valid factors: managerial and organisational ability, and government policy.)