Economics Research Lesson on Diminishing Returns and Increasing Marginal Cost

January 2, 2004

 

Developed for Economics 110 by Donna Anderson, T.J. Brooks, Lisa Giddings

Taught by Lisa Giddings and observed by T.J. Brooks

 

Goal of the lesson: To understand how the concept of marginality is linked to supply by examining the concept of diminishing returns and evaluating its effect on marginal cost.

 

Rationale for the goal: Evidence that students are completing the principles of microeconomics course with less understanding of the supply side of a market compared to the demand side includes significantly lower scores on exams covering supply-side concepts, and evidence from the intermediate microeconomics course.  This concern led us to focus on an essential microeconomic concept identified by our department the previous year:  diminishing returns in production and its effect on marginal cost.

 

The standard approach to teaching increasing marginal cost is to begin with the theory of production and the law of diminishing returns, in which the primary result is a graphical display of a marginal product curve showing a negative relationship between a variable input, on the horizontal axis, and marginal product, on the vertical axis.  Then we try to relate declining marginal product to increasing marginal cost using graphs.  Lack of understanding of the link between marginal product and marginal cost is not found in multiple choice questions but rather in students’ written explanations of why marginal cost is upward sloping.  Students know that marginal cost is somehow related to diminishing returns, and so can pick out the best response in a multiple choice question[i].  But when asked to explain the relationship, they falter.   Treatment in the textbook is of no help and contributes to the confusion.  The chapter on production is easily the most boring in the text. 

 

Research Lesson: Production Experiment with Discussion

The lesson is in two parts.  The first part involves a production simulation[ii] in which books are produced on four different production lines.  Production simulation is a common method of teaching diminishing returns, in which peanut butter and jelly sandwiches, trail mix, and paper airplanes are common products.  What we have added to these experiments are questions designed to focus students on the important concepts of production, and the second part of the experiment in which cost figures are added in order to relate production and cost. 

 

Research Lesson Format

 

Research Lesson Sequence

·       The instructor gives a general overview of the experiment and then written directions to students.

·       Students do the experiment, recording total output after each round, with the instructor acting as timekeeper.

·      Upon completion of the sixth round, students calculate marginal product, then participate in an instructor-led class discussion of prepared questions[iii] that focus on possible explanations for variations in marginal product.

·       Cost figures are then provided for the inputs, students calculate and graph marginal cost, then participate in an instructor-led class discussion of prepared questions. [iv]

 

 



[i] Examples of multiple choice questions designed to test understanding of the relationship between marginal cost and marginal product. 

                1.                Which of the following is true at the point where diminishing returns set it?

                                a.                both marginal product and marginal cost are at a maximum.

                                b.                both marginal product and marginal cost are at a maximum.

                                c.                marginal product is at a maximum and marginal cost at a minimum.

                                d.                marginal product is at a minimum and marginal cost at a maximum.

 

            2.                When a firm increases its output in the short run, its marginal cost tends to rise because of:

               

a.                   Excessive fixed costs.

b.                   Diseconomies of scale.

c.                   Diminishing marginal returns.

d.                   Communication and management problems.

 

[ii] Directions: In this experiment books will be produced on four different production lines.  Each book will be produced using one sheet of paper that will be folded twice into a book.  A staple will then be inserted with in ¼ quarter inch of left fold on the long side of the book.  The word BOOK will be written on the top half of the front and the employee’s initials will be written in the lower right corner of the front.  Quality is important to consumers, so books that are not properly folded, stapled, or printed will be placed in the reject file.  Each employee will be paid a fixed amount for each book that meets quality standards, so the goal of the employee is to produce as many books that meet quality standards.  Initially, production will start with one employee on the production line, and then one more employee will added to each new period. One period is 60 seconds long.   At the end of each 60 second time period the books will be checked for quality and the number of quality books will be counted and recorded in the attached chart.  Required Resources:  The “firm” will provide the capital resources, which include tables, plant capacity, staplers, and pens.  The firm will also provide the paper for the books.  Students will serve as employees.

 

Experiment Results

 

Production Line One

Time Period                           Units of                Total                                          Marginal

                                                Labor                      Product (Q)                          Product

0

0

0

undefined

1

1

 

 

2

2

 

 

3

3

 

 

4

4

 

 

5

5

 

 

6

6

 

 

7

7

 

 

8

8

 

 

9

9

 

 

 

 

 

[iii] Discussion Questions

 

1.             How did your output vary as you increased your labor input?

 

2.             What things affected the productivity of your labor – i.e., what made your workers work harder?  Were all of your workers equally productive?

 

Is productivity affected by the method of compensation?  For example, would your productivity be different if you were paid using a piece rate method (per book produced) versus an hourly wage ($6/hour which comes to 10 cents a minute)? 

 

3.             Graph Marginal Product of labor in which “labor” is on the horizontal axis and “quantity” is on the vertical axis.

 

                                Describe how the graph looks and explain why it looks that way.

 

 

[iv] Costs: You are to generate the short run costs of production using the experimental results of production for your team.  Assume the hourly wage is $6 per unit of labor and then convert this wage to the appropriate wage for the time period used in production.  Assume the ingredient inputs in each book (paper, staplers) cost 25 cents to buy.    Assume the cost of renting the plant capacity and table, the cost of the stapler and pen, and the entrepreneur’s implicit cost sum to $2 per time period.

 

1. Calculate the following short-run costs at the various levels of quantity:

                               

                                Total Cost (TC)

Marginal Cost (MC)

 

2. Graph Marginal Cost.  Let “quantity” be on the horizontal axis, and “costs” be on the vertical axis.

 

3.  Explain the shape of the marginal cost curve.