Economic Principles: External Economies & Producer Equilibrium

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Questions and Answers

What type of cost cannot be recovered once incurred?

Total cost

Fixed cost

Sunk cost (correct)

Variable cost

What is the formula for calculating average cost (AC)?

AC = TFC + TVC

AC = TFC / TC

AC = TVC / Q

AC = TC / Q (correct)

Which of the following is considered a fixed cost?

Electricity usage

Raw materials

Labor wages

Rent for a building (correct)

Which cost varies according to the level of output?

Total variable cost Signup and view all the answers

What is the primary characteristic of a fixed cost curve in the short run?

It is a horizontal line Signup and view all the answers

What does marginal cost represent?

Cost of producing one additional unit Signup and view all the answers

Which of the following components is included in calculating average variable cost (AVC)?

Total variable cost Signup and view all the answers

What is an example of how large companies can benefit from external economies of scale?

Through joint research with universities Signup and view all the answers

What do iso-quants represent in production theory?

Combinations of inputs that yield the same output Signup and view all the answers

What role do governments often play in external economies of scale?

Providing preferential treatment to attract large companies Signup and view all the answers

What characterizes capital augmenting technical progress?

The marginal product of capital increases faster than the marginal product of labor. Signup and view all the answers

What is the relationship between total cost and output in the long run?

All costs become variable Signup and view all the answers

What is meant by producer equilibrium?

A state where output costs are minimized for a given level of production Signup and view all the answers

How can small companies benefit from external economies of scale despite their size?

Through geographic clustering with similar businesses Signup and view all the answers

What defines neutral technical progress?

Changes in the marginal product of labor and capital are equal Signup and view all the answers

What does an expansion path illustrate?

Input combinations for least cost across different production levels Signup and view all the answers

In which type of technical progress does the marginal product of labor increase faster than that of capital?

Labor augmenting technical progress Signup and view all the answers

What distinguishes implicit costs from explicit costs?

Implicit costs are incurred for owned resources while explicit costs are for hired resources. Signup and view all the answers

Which of the following statements is true regarding the Cobb-Douglas production function?

It always exhibits constant returns to scale. Signup and view all the answers

Who first proposed the Cobb-Douglas production function?

Wicksell Signup and view all the answers

What is the total fixed cost (TFC) in this production schedule?

Rs. 300,000 Signup and view all the answers

What are explicit costs?

Actual payments made by the firm for resources. Signup and view all the answers

How is opportunity cost defined?

The revenue sacrificed by not using a resource in its next best alternative. Signup and view all the answers

What is the marginal cost (MC) for producing the 6th unit?

Rs. 700 Signup and view all the answers

What does 'economic costs' primarily relate to?

Future costs involved in business decision-making. Signup and view all the answers

What is included in the social cost of production?

The combination of private costs and external costs. Signup and view all the answers

What is the average variable cost (AVC) when producing 5 units?

Rs. 460 Signup and view all the answers

How is the average fixed cost (AFC) calculated when producing 5 units?

TFC / output Signup and view all the answers

What happens to total variable cost (TVC) as production increases?

It increases Signup and view all the answers

At what point do total costs (TC) and total revenue (TR) equal each other?

Break Even Point (BEP) Signup and view all the answers

How is Total Revenue (TR) calculated?

TR = Q x P Signup and view all the answers

What is the Long Run Average Cost (LAC) also known as?

Planning Curve Signup and view all the answers

What does the Margin of Safety represent?

Excess of expected sales over BEP Signup and view all the answers

Which of the following statements is true about Marginal Revenue (MR)?

MR measures the addition to total revenue from selling one more unit Signup and view all the answers

What is the result when TC is greater than TR?

Loss Signup and view all the answers

What is the formula for calculating Break Even Point (BEP)?

BEP = Total Fixed Costs / Price Signup and view all the answers

Which of the following is NOT a use of Break-Even Analysis?

Calculating employee wages Signup and view all the answers

Study Notes

External Economies of Scale

A company experiences external economies of scale when its size leads to preferential treatment, often by governments.
Examples include tax breaks to attract job creators or infrastructure development subsidized by developers.
Large companies can also partner with universities for discounted research and development.
Small businesses can benefit from geographic economies of scale by clustering together in specific areas, like artists, galleries, and restaurants in an art district.

Producers Equilibrium - Expansion Path

An isoquant represents combinations of two inputs that yield the same output level.
An isocost line displays the various combinations of labor and capital that can be purchased with a given budget.
Producer equilibrium occurs when a firm minimizes the cost of producing a given output or maximizes output with a fixed input budget.
This is achieved when the ratio of marginal product to price is equal for both inputs (MPL/PL = MPK/PK).
The expansion path connects the optimal input combinations as production scales up, representing the least-cost combinations for each output level.

Technical Progress and Its Implications

Technical progress refers to advancements in production methods that allow more output from the same inputs.
Neutral technical progress equally increases the marginal productivity of labor and capital.
Labor-augmenting technical progress boosts the marginal productivity of labor more than capital.
Capital-augmenting technical progress increases the marginal productivity of capital more than labor.

Cobb-Douglas Production Function

Developed by Wicksell, it was statistically tested by Cobb and Douglas using US manufacturing data from 1899 to 1922.
It's a homogeneous function, meaning output changes proportionally with the input factors.
The Cobb-Douglas function exhibits constant returns to scale, meaning doubling inputs doubles output.

Cost Analysis

A production function shows how much output a firm can produce with its resources.
Profit maximization is achieved by producing at the output level that maximizes total revenue minus total cost.

Cost Concepts

Opportunity cost is the value of the best alternative use for resources.
Explicit cost is the actual money paid for resources, including wages, materials, and rent.
Implicit cost is the foregone value of resources owned by the firm, like the lost income from not renting out company-owned property.
Economic cost encompasses both explicit and implicit costs and focuses on future costs relevant to decision-making..
Social cost represents the total cost to society, including external costs borne by the community from production, such as pollution.
Sunk Cost is an unrecoverable cost already incurred and irrelevant to current decision-making.

Determinants of Short-Run Cost

Fixed cost (FC) remains constant regardless of output, including rent, equipment, and building costs.
Variable cost (VC) varies directly with output, incorporating wages, materials, and energy expenses.
Total cost (TC) is the sum of fixed and variable costs. (TC = FC + VC)
Average cost (AC) is the total cost per unit of output (AC = TC/Q).
Average variable cost (AVC) is the variable cost per unit (AVC = VC/Q).
Average fixed cost (AFC) is the fixed cost per unit (AFC = FC/Q).
Marginal cost (MC) is the additional cost of producing one more unit (MC = ΔTC/ΔQ).

Short-Run Cost Output Relationship

The fixed cost curve is horizontal as fixed costs don't change with output.
The total variable cost (TVC) curve slopes upwards as output rises because more variable inputs are required.
The total cost (TC) curve also slopes upwards, but it's higher than the TVC curve because it includes fixed costs.
The shape of average cost curves (AC, AVC, AFC) is influenced by the relationship between total costs and output.

Long-Run Cost

All costs are variable in the long run, as all factors of production can be adjusted.
There are no fixed costs in the long run.
Long-run average cost (LAC) is the envelope of all short-run average cost curves (SAC).
The LAC curve represents the minimum average cost for producing each output level in the long run.

Revenue

Total revenue (TR) is the total income from selling goods and services (TR = P x Q).
Average revenue (AR) is the revenue per unit of output (AR = TR/Q = P).
Marginal revenue (MR) is the increase in total revenue from selling one more unit (MR = ΔTR/ΔQ).

Break-Even Analysis

Break-even analysis studies the relationship between total cost (TC) and total revenue (TR).
The break-even point (BEP) is the output level where TC = TR, resulting in zero profit.
BEP is calculated as TFC / (P - AVC).
Output below BEP results in a loss, while output above BEP generates profit.

Margin of Safety

Margin of safety measures how much sales or output can decrease before reaching the break-even point.
It's calculated as (Actual Sales - BEP) / Actual Sales.

Uses of Break-Even Analysis

Determine the selling price needed for desired profits.
Calculate the sales volume required for a specific return on investment.
Forecast costs and profits based on output changes.
Guide decisions on sales mix.
Compare profitability across firms.
Analyze costs and revenue across various output levels.

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Description

This quiz covers concepts related to external economies of scale and producers' equilibrium, highlighting how companies benefit from external factors and the balance between cost and output. You will explore key terms like isoquants, isocost lines, and the advantages of clustering for small businesses.