Question 1: 25 10 18 ? ? ? 26 10 20 ? ? ? 27 10 21 ? ? ? Analyze the changes in thecalculated costs as quantity produced increases. Answer 1 Quantity (Q) Total Fixed Cost (TFC) Total Variable Cost (TVC) Total Cost (SRTC = TFC+TVC) Average Cost (SRAC = TC/Q) Marginal Cost (SRMC = ?TC/?Q) 25 10 18 28 1.12 – 26 10 20 30 1.15 2 27 10 21 31 1.14 1 1.
The above table is anindicative of a short run cost of production where for a certain period oftime, at least one input is fixed while others are variable. In a short runperiod, an organization cannot change the fixed factor of production, such ascapital, factory buildings, plant and equipments etc. however, the variablecost, such as raw material, employee wages etc changes with the level ofoutput. If a firm intends to increase its output in the short run, it wouldneed to hire more workers and purchase more raw materials.
The firm cannotexpand its plant size or increase the plant capacity in short run. Similarly,when demand falls, the firm would reduce the work hours or output, but cannotdownsize its plant.2. Total Fixed Cost.
Total fixedcost does not change with the change in output. It will remain constant evenwhen the output is zero.3.
Total Variable Cost.TVC isdirectly proportional to the output of the firm. Whenever output increases, TVCwill also increase. 4. Short Run Average Cost. SRACof a firm refers to per unit cost of output at different levels of production.
5. SRAC Chart- SRAC curve is generally U-shaped. It declines in thebeginning, reaches to a minimum and starts to rise.
However, in this particularcase the there is a downward slope of SARC curve which indicates that as theoutput is increased, the average cost decreases. When a firm utilizes itcapacity to the full, the average cost reaches to a minimum. It is at thispoint that the firm operates at its optimum capacity.
6. Short Run Marginal Cost.Marginal Cost (MC) can be defined as the change in the total cost of a firmdivided by the change in total output.
SRMC refers to the change in short runtotal cost due to a change in the firm’s output. 7. The marginal cost of a firm isused to determine whether additional units need to be produced or not. If afirm could sell the additional unit at a price greater than the cost incurredto produce the additional unit (marginal cost), the firm may decide to producethe additional unit. Question 2:- Assume that a consumer consumes two commodities X and Yand makes five combinations for the two commodities: Combination Units of X Units of Y A 25 3 B 20 5 C 16 10 D 13 18 E 11 28 Calculate Marginal rate ofSubstitution and explain the answer.
Answer 2:1. Marginal rate of substitution (MRS) refers to the rate atwhich one commodity can be substituted for another commodity maintaining thesame level of satisfaction. The MRS for two substitute good x and y may bedefined as the quantity of commodity X required to replace one unit ofcommodity Y such that the utility derived from either combination remains same.Let us understand this with an example: Indifference points Combination (Y+X) Change in Y (?Y) Change in X (?X) MRS (y, x) (?y/?x) A 25+3 – – – B 20+5 -05 2 -2.5 C 16+10 -4 5 -0.8 D 13+18 -3 8 -0.375 E 11+28 -2 10 -0.
2 2. Now let us analyze the indifference curve3. As the consumer moves from combination a to b onindifference curve, he/she sacrifices 05 units of X and get 2 units of Y.thereforeMRS (x, y) = -2.
54. Similarly it shows that as the consumer moves from a to ethe MRS diminishes from -2.5 to -0.2. The indifference curve is slopeddownwards towards the right. It shows the in order to maintain the same levelof satistfaction, as the consumer increases the consumption of commodity y,he/she reduces the consumption of commodity X. Question 3(A): Suppose the monthly income of anindividual increases from Rs 20,000 to Rs 35,000 which increase his demand forclothes from 40 units to 50 units. Calculate the income elasticity of demandand interpret the result.
Answer 3(A): 1. Monthly income of anindividual increases from Rs. 20,000/- to Rs. 35,000/- which increases hisdemands for clothes from 40 units to 50 units. The income elasticity of demandis calculated as follows Y = Rs.
20,000/-Y1 = Rs. 35,000/-?Y = 35,000-20,000 = 15,000Q = 40 unitsQ1 = 50 units?Q = 50-40 = 10Hence, elasticity of demand e(y) = x e(y) = x = 3.33 (>1)2. In this case the income elasticity of demand is more thanunity.
This happens when a proportionate change in the consumer income causes acompaaritively large increase in the demand of the product. In this case, anincrease in income by 42.8% leads to 20% increase in demand.Question 3(B): Quantity demanded for tea hasincreased from 300 to 450 units with an increase in the price of the coffeepowder from Rs 25 to Rs 30. Calculate the cross elasticity of demand betweentea and coffee and explain the relationship between the goods.Answer 3(B):1.
Quantity demanded for tea increased from 300 to 450units. Price of coffee powder inc from Rs.25 to Rs.30. The cross elasticity ofdemand is calculated as follows.X = Tea Y = coffeeQ(X) = 300?Q(X) = 150 (450-300)P(y) = 25?P(Y) = 05 (30-25)Hence, cross elasticity of demand e(c) = x E(c) = x = 2.5 2.
In this case, the cross elasticity of demand is positiveas the increase in the price of coffee has increased the demand for tea. Bystudying the concept of cross elasticity of demand, organization can forecastthe effect of the change in the price of a good (in this case : coffee) on thedemand of its substitute and complementary goods (in this case : tea)