Explain the relationship between the law of diminishing returns and a firm’s short-run cost curves.

Evaluate the view that monopoly is an undesirable market structure as it fails to achieve productive and allocative efficiency.

PLEASE NOTE: This question part is not on the syllabus for first teaching 2020/first exams 2022.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part A.

Answers may include:

• definitions of the law of diminishing returns, short run, costs of production, cost curves
• diagrams to show the effect of decreasing and then increasing marginal cost on the average total cost and on the average variable cost; marginal product increasing (total product rising at increasing rate) then decreasing (total product rising at decreasing rate)
• explanation of the relationship between (diminishing) marginal product, (increasing) marginal cost, average variable costs and average total costs
• examples of diminishing returns and their effect on short-run costs.

Marks should be allocated according to the paper 1 markbands for May 2013 forward, part B.

Answers may include:

• definitions of monopoly, productive efficiency, allocative efficiency
• diagrams to show productive and allocative inefficiency under profit-maximizing monopoly firm, economies of scale leading to lower prices and higher output
• explanation of why the profit maximizing choices of a monopoly firm lead to productive and allocative inefficiency
• examples of inefficiencies in monopoly markets in practice
• synthesis or evaluation (evaluate).

Evaluation may include: reasons why monopoly might be desirable (eg possibilities of economies of scale and the case of natural monopoly, the need to innovate to maintain economic profit, ability to finance research and development). Other reasons why monopoly may be undesirable (eg low quality of the products and services, x-inefficiency).

Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.

Many candidates were able to either explain the law of diminishing returns or draw correctly the shortrun cost curves for a firm. Only a few were able to produce a complete answer by explaining the crucial link between diminishing marginal product and increasing marginal cost. The best candidates were able to support their answers with a numerical and/or hypothetical example of diminishing marginal product (increasing marginal cost). Some candidates confused diminishing marginal returns with diminishing marginal utility. Other candidates got off-track by confusing diminishing marginal returns with diseconomies of scale.

The great majority of candidates were able to draw a monopoly diagram and correctly determine the profit-maximizing level of output. Considerably fewer candidates were also able to show (correctly!) on the diagram the levels of output associated with allocative and productive efficiency. Some candidates were able to identify either the positive or the negative features of monopoly but did not explore the both sides of the issues as the question implies.