Economics Chapter on Opportunity Cost

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Questions and Answers

What does the relationship between Average Cost (AC) and Marginal Cost (MC) indicate when AC is at a minimum?

MC is equal to AC. (correct)

MC is greater than AC.

MC is less than AC.

MC does not affect AC.

In the context of production, what does the Law of Diminishing Marginal Productivity state?

Input costs are irrelevant in determining productivity.

Adding more of a variable input will eventually lead to lower per-unit output. (correct)

More inputs always increase output proportionally.

Marginal productivity continues to increase indefinitely with added inputs.

Which of the following best describes economic profit?

Revenue generated from hard costs only.

Total revenue minus total fixed cost.

Total revenue minus total variable cost.

Total revenue minus both explicit and implicit costs. (correct)

What is the significance of plotting total revenue, total variable cost, and total fixed cost?

To assess total profit and make production decisions. Signup and view all the answers

What is opportunity cost in the context of production?

The profit gained from the second-best alternative foregone. Signup and view all the answers

What does the term 'opportunity cost' signify in the context of owner-supplied resources?

The best return the owner could have received from using the resources elsewhere. Signup and view all the answers

Which components make up the economic cost of a firm?

Explicit Cost and Implicit Cost. Signup and view all the answers

How is economic profit calculated?

Total Revenue minus (Explicit Cost plus Implicit Cost). Signup and view all the answers

What distinguishes fixed costs from sunk costs in a business context?

Fixed costs can be recovered if production stops, while sunk costs cannot. Signup and view all the answers

Which of the following best describes implicit costs?

Non-monetary opportunity costs associated with using one's own resources. Signup and view all the answers

In the short run, what components does total cost consist of?

Fixed costs and variable costs. Signup and view all the answers

What happens to variable costs in the short run when production levels change?

They vary directly with the level of production. Signup and view all the answers

If a manager returns a railcar after one month for a Rs.10,000 lease with a repayment of Rs.4,000, what is the sunk cost associated with it?

Rs.10,000. Signup and view all the answers

In which stage of production is the Marginal Product of Labor (MPL) greater than Average Product of Labor (APL) but still positive?

Stage 1 Signup and view all the answers

What does the Law of Diminishing Marginal Productivity state regarding MPL and APL in Stage 3?

MPL is negative while APL is positive. Signup and view all the answers

What equation represents the long run production function?

Q = f(L, K) Signup and view all the answers

Which of the following correctly defines opportunity cost in production?

It includes the opportunity cost of both market supplied and owner supplied resources. Signup and view all the answers

Which resource type is characterized as being owned by others and purchased or rented by firms?

Market supplied resources Signup and view all the answers

What does the term 'explicit cost' refer to in economic terms?

Monetary payments made for market supplied inputs. Signup and view all the answers

What can lead to returns to scale in production?

Division of labor and specialization Signup and view all the answers

In which stage of production does a producer typically operate, characterized by a convex iso-quant?

Stage 2 Signup and view all the answers

Study Notes

Opportunity Cost

Opportunity cost represents the potential returns lost when resources are utilized internally instead of being sourced externally.
Implicit cost is the non-monetary opportunity cost associated with using a firm's own resources.

Economic Profit

Economic profits calculated as the difference between Total Revenue and the sum of Explicit and Implicit Costs.
It can be expressed in the form: Economic Profit = Accounting Profit - Implicit Cost.

Firm's Cost in Short Run

Cost structure in the short run: Total Cost = Fixed Cost + Variable Cost.
Fixed Cost remains constant regardless of production levels, related to the hiring of fixed inputs.
Variable Cost fluctuates with production levels, linked to the hiring of variable inputs.

Fixed Cost and Sunk Cost

Fixed Cost is recoverable if production ceases while Sunk Cost is irretrievable and represents losses incurred.
Example: Leasing a railcar; Rs. 10,000 total fixed cost and Rs. 6,000 sunk cost (after one month) based on lease terms.

Stages of Production

Stage 1: Marginal Product of Labor (MPL) exceeds Average Product of Labor (APL) and both are positive.
Stage 2: APL is greater than MPL, both remain positive; optimal production occurs here.
Stage 3: MPL exceeds APL but MPL becomes negative, indicating diminishing returns.

Long Run Production Function

Production function represented as Q = f(L, K) where Q is output based on labor (L) and capital (K).
The Marginal Rate of Technical Substitution of Labor for Capital (MRTSLK) indicates efficiency in input use.
Iso-quants represent combinations of inputs producing the same output; a convex iso-quant indicates productive efficiency.

Return to Scale

Return to scale describes how output changes as all inputs change proportionately.
Factors influencing return to scale include division of labor, specialization, and managerial challenges, such as inventory control.

Cost Function

Opportunity cost related to production considers both market-supplied resources (hired, rented) and owner-supplied resources.
Total economic cost equals the cumulative opportunity cost of both categories of resources.
Explicit costs are direct monetary payments for market-supplied inputs.

Relationship Between Costs

Average Cost (AC) is derived from fixed and variable costs associated with production.
Marginal Cost (MC) reflects the change in total cost from producing one more unit, calculated using cost function derivatives.

Cost Curves

When Average Cost is minimized, it equals Marginal Cost indicating efficiency in resource allocation.
Graphical representation includes total revenue, total variable costs, total fixed costs, and total profit to analyze profitability.

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Description

This quiz covers the concepts of economic profit, opportunity cost, and the distinction between explicit and implicit costs. Understand how these financial principles apply to owner-supplied resources in a firm. Test your knowledge with questions that clarify these important economic terms.