Where does the firm Operate?
The firm will avoid stages I, II and III and will instead choose stage II. It will avoid stage I because this shall involve using the fixed factor inefficiently because its MPP is increasing since the variable input is spread to scarcely (thinly) over the fixed input. Expansion of the variable input will permit specialization, hence increased output because of effective use of the variable input.
The firm shall avoid stage III because MPP for the variable input is negative.
Stage II is chosen because the marginal returns for both resources is diminishing. Here the MPP and APP are declining but the MPP of both resources is positive. With one factor fixed, and additional unit of the variable input increases total product. Therefore the firm which attempts to be economically efficient operates in stage II.