Hey,

This is probably pretty basic stuff, but I'm taking Econ 101 in university this semester and we're covering supply/demand right now. The part I don't understand is, why is the supply curve slope upwards so that progressively higher prices are required to increase supply?

The text book explains this with "increasing marginal cost", suggesting that it costs more to further increase production when you are already producing a lot.

However, this does not make any sense to me. Doesn't that contradict the whole point of economies of scale, which have proven quite successful? By taking advantage of fixed costs, wouldn't increasing production actually lower your cost per unit?

Am I misunderstanding this or is the book oversimplified/wrong?

Yeah that's exactly what I'm asking about.

But what I'm asking is, why the diminishing returns? I could understand if we were looking from the perspective of the whole economy, where eventually you're going to have to apply factors of production that aren't ideal for your product, but what causes this in the context of a single firm?

SmoothTalker said:

Yeah that's exactly what I'm asking about.

But what I'm asking is, why the diminishing returns? I could understand if we were looking from the perspective of the whole economy, where eventually you're going to have to apply factors of production that aren't ideal for your product, but what causes this in the context of a single firm?

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Because eventually firms will reach their profit maximization and hiring additional workers or adding more input won't matter in the out come. The only way for the firm to increase it's profit is to construct another factory. It's like hiring too many people, eventually people will get into each other's way and thus the wage is more than what they are producing.

As a perspective of the consumer marginal returns works in consuming products. You might value your first laptop at 1 grand, but after the first one you really don't need the second one. So consumer will only be willing to pay for half of the price. Eventually they'll stop consuming since it's too much. Like who would want 20 laptops for themselves?

Danger said:

Firms have two methods of production....

1) Capital
2) Workers

Workers are much easier to add or remove then capital is. Therefore you have limited Capital (tools) for your workers. More workers means having a smaller amount of capital to work with, thus producing less and less per worker, thus increased marginal cost.

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You mean labor right? It doesn't matter how many workers you have, eventually they'll get in each other's way and it'll become counter productive. They won't be producing efficiently and their labor cost is less than their wage. That is what causes diminishing marginal returns. More cost less profit.

1. The obvious answer is that when the price is high, more sellers will enter the market to sell goods and make money. Why would you want to be a seller if the price is low?

2. Economies of scale occur in the "long run" of economics, where sellers can increase ALL of their factors of production -- land, labor, machinery, etc. In the short run, where land and machinery are held constant, an increasing number of workers will result in diminishing productivity per worker. Building new machinery and acquiring new land takes longer than hiring a new worker.

Regarding a firm's supply curve (not the market supply curve), it will shift 0utward when the firm acquires more machinery.

SmoothTalker said:

is the book oversimplified/wrong?

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It's Macro-Economics. Supply and Demand here looks at all the industries in an economy. The premise to be aware of is Scarcity of resources, which in your example is what causes the production cost to rise as the supply rises.

Thanks to everyone, that helped.

I actually didn't read your question carefully enough. Regarding a FIRM's supply curve...

A firm always maximises its profit when its marginal cost equals its marginal revenue. The marginal cost is the supply curve because it shows the amount that a firm must produce to maximize profit for every level of price.

Meanwhile, the marginal revenue curve is twice the slope of the demand curve. The point where these two curves intersect will tell you how much output will be supplied -- and that point is obviously dependent in part on where the marginal cost curve runs.

Diminishing returns for labor is like this. Say you own a pizzeria. With only one worker, the person has to bake the pizzas, work the cash register, handle phone calls, ect. A second worker distributes the work load more, so productivity increases. A third worker also increases productivity.

But your benefit peaks at a certain point; you don't need 100 workers for a pizzeria, and hiring 100 workers would just cost you a bunch in payroll.

Okay something still doesn't add up then.

Evzone, yeah you don't need a hundred workers in one pizzeria. So if you needed to further increase production, you'd build a new pizzeria.

I just don't see how workers interfering with each other outweighs the benefits of specialization, mass production, and various other cost savings.

And why would the workers interfere with each other anyway? Who says you can't expand your facilities too, if your product is in such high demand?

Can someone answer this: If marginal cost for a firm to produce a product increase as quantity produced increases, then why was mass production so successful?

I thought it was specifically because costs DECREASE the more you make of something.

We've actually been kinda confusing two distinct concepts: 1. Diminishing marginal returns and 2. Increasing marginal cost. They're similar, but not really the same thing.


And you're really thinking about things too expensively, as opposed to logically. The graph you're talking about charts TWO variables: Price and Quantity. The amount of machinery and space is held constant. Even the number of laborers is held constant. Stop adding extra variables to the equation that aren't there. That's for a different discussion. Before you get to economies of scale you have to master the more basic concepts.

If you tell your pizzeria workers that instead of 100 pizzas per day, you're going to have them stay there all night so you can make 800 pizzas per day, they're going to get pretty pissed. Your marginal costs will increase because 1) the workers will be tired so they will probably take longer to make each pizza, while you're paying them by the hour, 2) alternatively the workers may get sloppy and try to rush output, mishandling the ingredients and wasting a lot of dough due to burned pizzas or food dropped on the floor, and 3) the workers will probably ask for a higher wage to make up for the fact that you're working them 100+ hours per week. Increasing marginal cost derives from the basic concept that expanding production with a set amount of resources will result in inefficiency.


Diminishing returns to labor, on the other hand, means that if you keep on hiring workers then you'll eventually come to a point where you're just throwing money away on workers who will have to sit around doing nothing. It only takes about 5 people to run a Pizza Hut. If you cram 20 people in there, you will probably come out with pizzas a little faster, but adding a 20th worker (compared to 19) won't help nearly as much as adding a 5th worker (compared to 4). Eventually, the marginal returns will diminish so much that they will actually be negative. That's when you try to crowd 50 people into a small pizza shop so that people can barely even move.

If, on the other hand, you built three new pizza shops, it would make sense to hire the 15 extra workers.



Diminishing marginal returns: Buying 5 new DVDs off Ebay will help me. Buying 100 new DVDs off Ebay will probably be a waste of money.

Increasing marginal cost: Asking for regular shipping may cost me $4. Asking the merchant to hop aboard a Concord jet and get me the DVDs within five hours will probably be prohibitively expensive, because the guy has better things to do with his time, he'd have to get an airplane ticket, etc.

OKay, now I get it. I think what I was missing was that everything else had to be held constant. In that case it makes sense.