http://economicsdetective.com/ Recall the basic cost minimization problem established in "Firms and Profits". We had this funny curve called an "isoquant", which cut through all the combinations of capital and labour that produced exactly 3 airplanes. What accounts for the shape of the curve? In theory, we could have any sort of curve we care to imagine, but to be realistic we need to realize some things: One, workers aren't useful without any tools, and two, tools aren't useful without any workers. Well, unless those tools are robots. Robots are awesome. In any case, assuming the tools aren't awesome robots, there's a benefit to having a balance between tools and workers. If every worker gets his own toolkit and doesn't have to share, they'll be pretty productive. If he has to share with other workers, some of his time will be wasted waiting for someone else to finish with his wrench. If he has many toolboxes to himself, well, he's happy, but most of those extra tools aren't getting used all that much. So we have this curve, it represents all the points that make the same exact number of airplanes, say 50. Let's draw some more level sets. This level set might be all the combinations of capital and labour that produce 30 airplanes, and this one produces only 20, and these ones produce 60, 80, and 100 airplanes. Now, what do these lines remind you of? Well, they should look a little bit like the topographic lines on a map, because it's the same exact concept. On a map, there's a line for everything 50 meters above sea level, and 60 meters above sea level, and 70, and 80, etcetera. Where the lines are close together, you've got a steep slope, and where the lines are far apart, you have a gentle slope. Well, we're going to take a walk on this map. We're going to start with 100 units of capital and no labour, and we're going to see what happens as we add more labour to our fixed stock of capital. We can make a new graph of airplane production per unit of labour as we go. To start, we've got no labour and we produce no airplanes. When we add those first few units of labour, those workers have all the tools to themselves, so we have rapidly climbing productivity. As with a topographical map, when we cross a lot of lines, we're climbing fast. As we add more labour, the workers have to share their tools more, so while airplane production is still climbing, it's not climbing as fast. Eventually, the workers all start to get in each other's way, they have to share tools with many other workers, and production climbs very slowly. So we have this curve, and we're getting what economists call diminishing marginal returns to labour. What it doesn't show us is how much this airplane production costs. Well, no matter what we have to pay ... https://www.youtube.com/watch?v=XwZhXRKrbS8