Cost, Revenue, and Supply
Multiple Choice Questions (MCQs)
Which of the following refers to the money expenses incurred by a firm in the process of production?
a) Real Cost
b) Implicit Cost
c) Money Cost
d) Opportunity Cost
Correct Answer: c) Money Cost
The cost of self-owned and self-employed resources used in production is known as:
a) Explicit Cost
b) Money Cost
c) Implicit Cost
d) Fixed Cost
Correct Answer: c) Implicit Cost
In the short run, costs that do not vary with the level of output are called:
a) Variable Costs
b) Opportunity Costs
c) Fixed Costs
d) Marginal Costs
Correct Answer: c) Fixed Costs
Total Cost (TC) is the sum of:
a) Explicit Cost and Implicit Cost
b) Fixed Cost and Marginal Cost
c) Variable Cost and Marginal Cost
d) Total Fixed Cost and Total Variable Cost
Correct Answer: d) Total Fixed Cost and Total Variable Cost
Marginal Cost (MC) is defined as:
a) The total cost divided by the quantity produced.
b) The fixed cost divided by the quantity produced.
c) The additional cost incurred by producing one more unit of output.
d) The variable cost divided by the quantity produced.
Correct Answer: c) The additional cost incurred by producing one more unit of output.
When Marginal Cost (MC) is less than Average Total Cost (ATC):
a) ATC is increasing.
b) ATC is decreasing.
c) ATC is at its minimum.
d) MC is at its maximum.
Correct Answer: b) ATC is decreasing.
Average Fixed Cost (AFC) curve is:
a) U-shaped
b) Inversely U-shaped
c) Downward sloping and rectangular hyperbola
d) Upward sloping
Correct Answer: c) Downward sloping and rectangular hyperbola
Total Revenue (TR) is calculated as:
a) Price × Quantity Sold
b) Marginal Revenue × Quantity Sold
c) Average Revenue × Marginal Revenue
d) Total Cost + Profit
Correct Answer: a) Price × Quantity Sold
Average Revenue (AR) is always equal to:
a) Total Revenue
b) Marginal Revenue
c) Price
d) Total Cost
Correct Answer: c) Price
When Marginal Revenue (MR) is positive and decreasing, Total Revenue (TR) is:
a) Decreasing
b) Increasing at an increasing rate
c) Increasing at a decreasing rate
d) At its maximum
Correct Answer: c) Increasing at a decreasing rate
If Marginal Revenue (MR) is zero, Total Revenue (TR) is:
a) Increasing
b) Decreasing
c) At its maximum
d) Negative
Correct Answer: c) At its maximum
The Law of Supply states that, other things being equal, there is a direct relationship between:
a) Price and quantity demanded.
b) Price and quantity supplied.
c) Income and quantity supplied.
d) Cost and quantity supplied.
Correct Answer: b) Price and quantity supplied.
A movement along the supply curve is caused by a change in:
a) Technology
b) Input prices
c) Price of the good itself
d) Government policy
Correct Answer: c) Price of the good itself
Which of the following would cause a 'shift to the right' of the supply curve?
a) An increase in the cost of raw materials.
b) A decrease in the number of firms in the market.
c) Improvement in production technology.
d) An increase in the price of the good itself.
Correct Answer: c) Improvement in production technology.
When Average Variable Cost (AVC) is at its minimum, Marginal Cost (MC) is:
a) Equal to AVC
b) Less than AVC
c) Greater than AVC
d) Zero
Correct Answer: a) Equal to AVC
Short Questions
Define Real Cost.
Answer: Real cost refers to the pain, disutility, effort, and sacrifices of all kinds undergone by the producers or owners of factors of production in the process of producing a good or service. It's a non-monetary measure of cost.
What is the difference between explicit cost and implicit cost?
Answer: Explicit costs are direct monetary payments made to outsiders for factors of production and other inputs (e.g., wages, rent, raw material payments). Implicit costs are the imputed costs of self-owned or self-employed resources used in production, for which no direct monetary payment is made (e.g., the imputed rent of a self-owned building, the entrepreneur's own wages not paid by the firm).
Give two examples of fixed costs for a manufacturing firm in the short run.
Answer: Two examples of fixed costs are: rent for the factory building and salaries of permanent administrative staff.
Give two examples of variable costs for a manufacturing firm in the short run.
Answer: Two examples of variable costs are: cost of raw materials and wages of casual or daily-wage laborers.
How is Average Fixed Cost (AFC) calculated? What is its typical shape?
Answer: Average Fixed Cost (AFC) is calculated by dividing Total Fixed Cost (TFC) by the quantity of output (Q): AFC= TFC/ Q
. Its typical shape is downward sloping, resembling a rectangular hyperbola, as fixed cost is spread over more units of output.
State the relationship between Total Cost (TC), Total Fixed Cost (TFC), and Total Variable Cost (TVC).
Answer: Total Cost (TC) is the sum of Total Fixed Cost (TFC) and Total Variable Cost (TVC). So, TC=TFC+TVC.
What is Total Revenue (TR)?
Answer: Total Revenue (TR) is the total amount of money received by a firm from the sale of a given quantity of output. It is calculated as Price × Quantity Sold.
How is Marginal Revenue (MR) calculated?
Answer: Marginal Revenue (MR) is the additional revenue earned by selling one more unit of output. It is calculated as Change in Total Revenue/ Change in Quantity Sold or MR n =TR n −TR n−1
State the Law of Supply.
Answer: The Law of Supply states that, other things being equal (ceteris paribus), there is a direct (or positive) relationship between the price of a commodity and its quantity supplied. As the price rises, the quantity supplied increases, and as the price falls, the quantity supplied decreases.
Name any three determinants of supply (other than the price of the good itself).
Answer: Three determinants of supply are:
Technology of production
Price of inputs (factors of production)
Government policies (e.g., taxes and subsidies)
Long Questions (5 Marks each)
1.Explain the concepts of Total Cost (TC), Total Fixed Cost (TFC), Total Variable Cost (TVC), Average Total Cost (ATC), Average Variable Cost (AVC), Average Fixed Cost (AFC), and Marginal Cost (MC) in the short run. Discuss the typical relationship between MC, AVC, and ATC curves with a brief explanation.
Answer:
In the short run, a firm operates with at least one fixed factor of production (e.g., plant size) and some variable factors (e.g., labor, raw materials). Costs are categorized based on their variability with output.
Cost Concepts in the Short Run:
Total Fixed Cost (TFC): These are costs that do not change with the level of output. They are incurred even if output is zero. Examples: rent for factory building, salaries of permanent staff, depreciation of machinery.
Total Variable Cost (TVC): These are costs that vary directly with the level of output. They are zero when output is zero. Examples: cost of raw materials, wages of daily-wage laborers, electricity charges based on usage.
Total Cost (TC): This is the sum of total fixed cost and total variable cost at each level of output. TC=TFC+TVC.
Average Fixed Cost (AFC): This is the fixed cost per unit of output. As output increases, TFC is spread over more units, so AFC continuously declines and approaches zero. AFC= TFC/ Q
Average Variable Cost (AVC): This is the variable cost per unit of output. Initially, AVC may fall due to increasing returns, then rise due to diminishing returns. AVC= TVC/ Q
Average Total Cost (ATC) or Average Cost (AC): This is the total cost per unit of output. It is the sum of AFC and AVC. ATC= TC/ Q =AFC+AVC. Its shape is typically U-shaped
Marginal Cost (MC): This is the additional cost incurred by producing one more unit of output. It reflects the change in total cost (or total variable cost) as output changes by one unit. MC= ΔTC/ ΔQ or MC n =TC n −TC n−1
Relationship between MC, AVC, and ATC Curves (U-shaped Curves):
The relationship between MC, AVC, and ATC curves is crucial for understanding a firm's short-run cost behavior. All three (AVC, ATC, MC) are typically U-shaped due to the Law of Variable Proportions (increasing and then diminishing returns).
MC and AVC Relationship:
When MC < AVC: AVC is falling. (Adding an additional unit costs less than the average, pulling the average down).
When MC = AVC: AVC is at its minimum point. (The additional unit costs exactly the average, so the average stops falling).
When MC > AVC: AVC is rising. (Adding an additional unit costs more than the average, pushing the average up).
MC curve always intersects the AVC curve at its minimum point.
MC and ATC Relationship:
When MC < ATC: ATC is falling.
When MC = ATC: ATC is at its minimum point.
When MC > ATC: ATC is rising.
MC curve always intersects the ATC curve at its minimum point.
ATC and AVC Relationship:
ATC is always higher than AVC (because ATC includes AFC, which is always positive).
The vertical distance between ATC and AVC curves continuously decreases as output increases because AFC continuously decreases.
Brief Explanation: The MC curve's U-shape is a direct consequence of the Law of Variable Proportions (or Diminishing Marginal Returns). When MP is rising, MC is falling. When MP is falling, MC is rising. Since MC represents the cost of producing an additional unit, it influences the average costs. When the cost of an additional unit is below the average, it pulls the average down; when it's above the average, it pushes the average up. This is why MC intersects AVC and ATC at their respective minimum points.
2.Explain the concepts of Total Revenue (TR), Average Revenue (AR), and Marginal Revenue (MR). Discuss their relationships with each other under different market conditions: (a) when price is constant (e.g., perfect competition) and (b) when price falls with an increase in quantity sold (e.g., monopoly or monopolistic competition).
Answer:
Relationships under Different Market Conditions:
(a) When Price is Constant (e.g., Perfect Competition):
In a perfectly competitive market, individual firms are price-takers. They face a perfectly elastic demand curve, meaning they can sell any quantity at the prevailing market price. The price remains constant regardless of how much an individual firm sells.
AR = MR = Price (P): Since the price is constant for every unit sold, the additional revenue from selling one more unit (MR) is always equal to the price, which is also equal to the average revenue.
TR: Total Revenue increases at a constant rate (equal to the price). TR curve is a straight line passing through the origin with a positive slope.
Diagram (Imagine):
AR and MR curves are a single horizontal line parallel to the X-axis at the market price.
TR curve is an upward-sloping straight line from the origin.
(b) When Price Falls with an Increase in Quantity Sold (e.g., Monopoly or Monopolistic Competition):
In imperfectly competitive markets (like monopoly or monopolistic competition), the firm faces a downward-sloping demand curve. To sell more units, the firm must lower its price for all units.
AR > MR: Since the price must be lowered to sell an additional unit, the marginal revenue (the addition to total revenue) will be less than the price (average revenue). Each additional unit sold adds less to total revenue than the price at which it is sold because the price reduction also applies to previously sold units.
AR curve: Is the demand curve for the firm and slopes downwards.
MR curve: Is also downward sloping and lies below the AR curve.
TR: Total Revenue will initially increase at a decreasing rate, reach a maximum point (when MR = 0), and then start to decrease (when MR becomes negative).
Diagram (Imagine):
AR curve (demand curve) is downward sloping.
MR curve is downward sloping and lies below the AR curve.
TR curve is an inverted U-shape, maximizing when MR is zero.
Understanding these relationships is crucial for firms to make optimal pricing and output decisions, as maximizing profit often involves analyzing the interplay of marginal revenue and marginal cost.
3.Define supply in economics and explain the Law of Supply. Discuss the key determinants of supply (other than the price of the good itself) that can cause a shift in the supply curve, providing a brief explanation for each.
Answer:
Meaning of Supply:
In economics, supply refers to the quantity of a specific good or service that producers (firms) are willing and able to offer for sale at various possible prices during a specific period, assuming all other factors affecting supply remain constant (ceteris paribus). It indicates the producer's readiness to sell at different price levels.
Law of Supply:
The Law of Supply states that, other things being equal, there is a direct (or positive) relationship between the price of a commodity and its quantity supplied. This means:
As the price of a good rises, the quantity supplied increases.
As the price of a good falls, the quantity supplied decreases.
Reason for the Law of Supply: The direct relationship exists primarily because higher prices generally mean higher profitability for producers. A firm is incentivized to produce and sell more when it can earn greater profits. Conversely, lower prices reduce profitability, making producers less willing to supply as much.
Determinants of Supply (Factors Causing a Shift in the Supply Curve):
While the price of the good itself causes a movement along the supply curve, changes in other factors lead to a shift in the entire supply curve (either to the right, indicating an increase in supply, or to the left, indicating a decrease in supply).
Price of Inputs/Factors of Production:
Explanation: The cost of resources used in production (e.g., wages for labor, price of raw materials, rent for land) directly affects a firm's profitability.
Impact: If the price of inputs increases, production costs rise, making production less profitable at any given price. This leads to a decrease in supply (supply curve shifts left). Conversely, a decrease in input prices reduces costs and leads to an increase in supply (supply curve shifts right).
Technology of Production:
Explanation: Technological advancements can improve efficiency, reduce production costs, or enable the production of better quality goods with the same resources.
Impact: An improvement in technology generally leads to lower per-unit costs, making production more profitable. This results in an increase in supply (supply curve shifts right). A deterioration or outdated technology would decrease supply.
Government Policy (Taxes and Subsidies):
Explanation: Government intervention through taxes or subsidies directly impacts the cost structure and profitability of firms.
Impact:
Taxes (e.g., excise duty, GST): An increase in indirect taxes raises the cost of production per unit. This leads to a decrease in supply (supply curve shifts left).
Subsidies: Financial assistance provided by the government reduces the effective cost of production. An increase in subsidies leads to an increase in supply (supply curve shifts right).
Prices of Other Goods (Related Goods):
Explanation: Producers often have the flexibility to produce different goods using similar resources. The price of other goods can influence the supply of the good in question.
Impact: If the price of a related good (that can be produced with similar resources) increases, producers might shift resources to produce that more profitable good, leading to a decrease in the supply of the original good (supply curve shifts left). For example, if the price of wheat rises significantly, a farmer might reduce the supply of barley to grow more wheat.
Number of Firms in the Market:
Explanation: The total market supply is the sum of supplies from all individual firms.
Impact: An increase in the number of firms entering the market will lead to an increase in overall market supply (supply curve shifts right). Conversely, a decrease in the number of firms due to exits will decrease market supply.
Expectations about Future Prices:
Explanation: Producers' expectations about future prices can influence their current supply decisions.
Impact: If producers expect the price of their good to rise in the future, they might withhold some supply currently to sell it later at a higher price, leading to a decrease in current supply (supply curve shifts left). Conversely, if they expect prices to fall, they might increase current supply to sell before prices drop.
These determinants collectively explain why the supply of a product can change even if its own price remains constant, leading to a shift of the entire supply curve.
