Section A

Each question carries 1mark :

1. Define Fixed Cost.
Fixed costs are the costs that don’t change with the change in output of the good. For eg.
Interest, salary of permanent staff, etc.
2. Define Variable Cost.
Variable costs are costs which change with change in the output of a good. For eg. Cost on

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raw materials, labour, etc.
3. What does shaded area show in the figure alongside?

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a) TFC Fig .cost MC
b) TVC

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c) TC
d) ATC

4. Why does AFC fall as output rises? H O Output

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AFC = TFC/Output
Now as output increases, AFC falls as TFC (numerator) remains constant whereas the output
(the denominator) increases.
5. Define Marginal Cost.
Marginal cost is the addition to total cost of producing one more unit of output.
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6. Fixed costs are also known as

a) Supplementary cost
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b) Overhead costs
c) Indirect costs
d) All of these
7. TC is the vertical submission of :
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a) TFC &TVC
b) AFC &AVC
c) TVC & AVC
d) None of these
8. What is the behaviour of total variable cost as output increases?
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There are two phases in the behaviour of TVC as output increases:

First phase, TVC rises at a decreasing rate.
Second phase, TVC rises at an increasing rate.
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9. The total cost at 10 units of output is Rs 55.The fixed cost is Rs 5. The average variable
cost at 5 units of output is
a) Rs 25
b) Rs 6
c) Rs 5
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 d) Rs 1

10. The cost of zero level of output is equal to which cost?

Fixed cost
11. Why is TFC curve parallel to X-axis?
Fixed costs remain fixed. TFC curve remains constant when the output is increased. thus
TFC curve is always parallel to the X-axis
12. Why are total cost curve and total variable cost curve parallel to each other?

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Since the distance between TC and TVC remains the same (i.e. equal to TFC), the two curves

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never intersect each other because TFC can never be zero. Hence the two curves remain
parallel to each other.
13. What happens to the difference between Average Total Cost and Average Variable cost

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as production is increased?
AC= AFC+AVC.

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As output increases, AFC continuously fall, because TFC is constant. Consequently, the
component of AFC in AC tends to shrink. This brings AC closer to AVC, reducing gap
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between both the curves.
14. What happens to the difference between Total Cost and Total Variable cost as output is
increased?
As output is increased difference between Total Cost and Total Variable cost remains constant
as TFC remains fixed even with increase in output.
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15. What is the relation between Average Total cost and Average Variable cost, if Total
fixed cost is zero?
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If Total fixed cost is zero, Average Total cost and Average Variable cost will intersect each.
16. Why should TVC increase at a decreasing rate in the initial stages of production?
In the initial stages of production, a firm may be enjoying increasing returns to a factor. It is a
situation when MP tends to rise. Cost is just opposite of productivity. Rising MP means
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falling cost. When the cost of producing an additional unit is falling, TVC should be
increasing only at the decreasing rate
17. How is TFC affected when output is increased?
TFC being a fixed cost remains unaffected with the increase in output.
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18. What is the shape of the AFC curve?

AFC curve is downward sloping rectangular hyperbola.
19. Read the following statements: Assertion (A) and Reason (R). Choose one of the correct
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alternatives given below:

Assertion (A): Normal Profit is a part of Implicit Cost.
Reason (R): Normal Profit is the imputed value of entrepreneurial services provided by the
owner.
Alternatives:

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 a) Both Assertion and Reason are true and Reason (R) is the correct explanation of
Assertion (A)
b) Both Assertion and Reason are true and Reason (R) is not the correct explanation of
Assertion (A).
c) Assertion (A) is True but Reason (R) is False.
d) Assertion (A) is False but Reason (R) is True.
20. Statement 1: TFC curve is a vertical straight line parallel to the Y-axis.
Statement 2: TFC remains the same at all levels of output, even if the output is zero.

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Alternatives:

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a) Both the statements are true.
b) Both the statements are false.
c) Statement 1 is true and statement 2 is false.

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d) Statement 1 is false and statement 2 is True.
21. Assertion (A): Total Variable Cost (TVC) can be changed in the short run.
Reason (R)
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: TVC increases initially at a decreasing rate, then at a constant rate, and,
finally, at an increasing rate.
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Alternatives:
a) Both Assertion and Reason are true and Reason (R) is the correct explanation of
Assertion (A).
b) Both Assertion and Reason are true and Reason (R) is not the correct
explanation of Assertion (A).
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c) Assertion (A) is True but Reason (R) is False.

d) d) Assertion (A) is False but Reason (R) is True.
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22. Assertion (A): AFC curve can never touch the Y-axis.
Reason (R): TFC can never be zero.
Alternatives:
a) Both Assertion and Reason are true and Reason (R) is the correct explanation of
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Assertion (A).
b) Both Assertion and Reason are true and Reason (R) is not the correct explanation of
Assertion (A).
c) Assertion (A) is True but Reason (R) is False.
d) d) Assertion (A) is False but Reason (R) is True.
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23. Statement 1: TC and TVC curves are parallel to each other.

Statement 2: The vertical distance between TC and TVC curves is TFC, which remains
constant at all levels of output.
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Alternatives:
a) Both the statements are true.
b) Both the statements are false.
c) Statement 1 is true and statement 2 is false.
d) Statement 2 is true and statement 1 is false.

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 Each question carries 3/4 marks:

24. Distinguish between fixed costs and variable costs.

Fixed cost (FC) Variable cost (VC)
Fixed Costs are the costs which do not Variable costs are the costs which change
change with change in the output of a good. with the change in output of a good.
Fixed Costs are incurred on the fixed factors Variable costs changes with change in the
of production like machines, buildings, level of output.

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insurance etc.
FC cannot be changed during short run. VC can only be changed during short run.

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FCs exists even at zero level of output. VCs doesn’t exist at zero level of output.
Graphically, TFC curve is parallel to x- Graphically, TVC curve is inverse S-

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axis. shaped.

25. What is the relationship between AVC and MC? Represent diagrammatically.
i.
ii.
If MC is less than AVC then AVC falls.
If MC is equal to AVC then AVC is constant. H
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iii. If MC is more that AVC then AVC rises.

Diagram cost y AVC

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MC
Cost
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0 output
26. Explain the relationship between AC and MC with the help of a cost schedule.
i. Define AC and MC
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OUTPUT AC(Rs) MC(Rs)

1 12 10
2 8 6
3 6 2
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4 6 6
5 8 16
6 10 20
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ii. Both AC and MC are u shaped because of law of variable proportions.

iii. As long as AC is greater than MC, average cost falls. AC curve is above MC curve.
iv. AC=MC When AC is at its lowest point. Hence MC curve cuts AC curve from below
at its lowest point called point of optimum capacity.
v. When MC is greater than AC, AC rises. MC pulls up AC. Hence MC curve is above
AC curve.
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 vi. MC reaches its maximum point before AC reaches its maximum point.
27. Distinction between explicit cost and implicit cost. Give examples
Explicit costs -The direct expenditure on actual purchases or hiring of inputs is called
explicit costs. It is recorded in books of accounts
For example, salaries of employees, expenditure on raw materials.
Implicit costs -The indirect expenditures refer to the estimated value of inputs provided by
the owners which do not find place in the account books, it is called implicit cost.
For example, estimated salary of the owners, estimated interest of financial investment.

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28. Define Variable cost. Explain the behaviour of TVC as output increases.

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Variable costs are costs which change with change in the output of a good. For e.g. Cost on
raw materials, labour, etc.
The behaviour of TP is derived from the behaviour of TP implied in law of Variable

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proportion There are two phases in the behaviour of TVC as output increases.
First phase, TVC rises at a decreasing rate.

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TVC rises at decreasing rate .It means every new output produced involves a lower cost It is
because of the increase in the efficiency of variable input due to proper utilization of fixed
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inputs, specialisation and division of labour.
Second phase, TVC rises at an increasing rate.
This means that every new unit of output has a higher cost as compared to the previous unit.
This is on account of fall in efficiency of the variable input due to overutilization of fixed
inputs
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Diagram y TVC
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cost

O X Output
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29. Draw Total Variable Cost, Total Cost and Total Fixed Cost curves in a single diagram.
Total cost is the sum of TFC and TVC. TC starts at the point of fixed cost. It initially
increases at a decreasing rate then increase at an increasing rate. TC is always parallel to
TVC as the gap
Indicates TFC, which is constant at all levels of output.
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Diagram
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 TC
TVC

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Cost TFC

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0 X output

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30. A producer starts a business by investing his own savings and hiring the labour.
Identify the implicit and explicit costs from this information. Explain.
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a) Interest on own capital: Implicit Cost and
b) Wages paid to Hired Labour: Explicit Cost
(Explain wrt definitions of explicit and implicit cost.)
31. Giving reasons, state whether the following are true or false:
a) The difference between TC and TVC falls with increase in output- False. It remains
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constant due to constant TFC at all levels of output. TC=TFC+TVC.

b) AVC falls even when MC is rising, and is above MC. –True when MC starts rising,
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AVC is above MC because per unit variable cost falls at lesser rate than fall in
addition unit of hiring labour.
32. Why is the MC curve U-shaped in the short run?
MC curve is u shaped. It initially decreases with the increase in output and then rises with the
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output. It is u-shaped because of law of variable proportions.

Initially the firm experiences increasing returns because of division of labour, specialization,
better utilization of fixed factors etc. as a result, the cost of production of additional units
declines. Hence MC curve falls. Later the firm experiences diminishing returns because of
optimum utilization of fixed factors, congestion and overcrowding of variable factors. As a
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result the cost of production of additional units goes up. Hence MC curve rises.
Diagram
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 Y
MC
cost

0 x output

33. Why does the difference between ATC and AVC decrease with an increase in the level of

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output? Can these two be equal at some level of output? Explain.

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AFC is Total fixed cost divided by units of output.. AFC = TFC/Output. As output increases
AFC falls as TFC remains constant and the output continues to increase.
AVC is total cost divided by output. AVC = TVC / Output. As output increases AVC falls

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initially and then rises after a level of output. It is a U-Shaped curve.
Because of falling AFC, ATC and AVC will move closer to each other but will never meet or
intersect as AFC can never be zero. y
H ATC
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Cost AVC
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0 X Output
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34. How is economic cost different from accounting cost? Explain.

Economic cost is always measured as opportunity cost. Opportunity cost of an activity is
measured in terms of the total sacrifice involved in undertaking that activity. Thus economic
cost of producing a given output always implies opportunity cost of producing that output
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and is to be measured in terms of the sacrifice involved in producing that output. From
producers point of view the sacrifice involved both implicit and explicit cost, on the other
hand accounting cost includes only explicit cost i.e. cost which is recorded in the books of
accounts.
35. What is the behaviour of a) Total Fixed Cost and b) Average Variable Cost as more and
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more units of a good are produced?

a) Total Fixed Cost
Total fixed cost remains constant at all levels of output.
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TFC curve therefore is parallel to X axis.., It means whether output is zero, OQ1 or OQ2 or
even higher TFC remains fixed at OF .It does not change with change in output
Diagram

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 y TFC
Cost

0 q q1 x output
b) Average Variable Cost

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AVC equals to TVC divided by output.

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As output expands AVC, falls initially and then rises after a level of output. It is a U shape
curve.
Diagram with brief explanation (as discussed in class)

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H
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Y Cost
Cost

O x Output
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36. Define fixed cost. Give an example. Explain the behaviour of average fixed cost as
output is increased.
DA

Fixed Costs are the costs which do not change with change in the output of a good.
Example- salary of permanent staff.
AFC- Definition, formula, dia. with explanation (as discussed in class).
Each question carries 6 marks:
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37. Giving reasons, explain whether the following statements are true or false.
i. As output is increased, the difference between ATC and AVC falls and ultimately
becomes zero –
False. As output is increased, the vertical difference between ATC and AVC goes on
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decreasing. The reason is that ATC-AVC = AFC and AFC by definition goes on
decreasing as output is increased but it is never zero since TFC is never zero and
hence the difference between ATC and AVC cannot be zero.
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ii. Total Cost curve is always upward sloping –

True. Total cost cannot decrease with increase in production of units of output. Hence
it is always upward sloping. It is an upward sloping inverse S shape curve.
38. Why is AC curve U-shaped?

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 Short run average cost is a U-shaped. It means that at first, this curve tends to fall and after
reaching the minimum point, it begins to rise.
It finds its explanation in the law of variable proportions.

The law of variable proportion states that initially (so long as fixed factor remains
underutilized), MP (marginal product) of the variable factor tends to rise. And, eventually
(after fixed factor and variable factor reach their ideal ratio or optimum ratio), MP of the
variable factor tends to fall.

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Let variable factor be L (Labour) and fixed factor be K (Capital). When MPL tends to rise it
means more of output per every additional unit of L. Rising MP also implies an increase in
AP.

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It means, requirement of L per unit of output tends to fall (in a state of increasing returns to a

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factor). Ultimately it means cost of the variable factor L per unit of output tends to fall. Or,
that AVC tends to fall.
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Exactly opposite is the situation when diminishing returns are in operation. Thus, AVC
assumes U-shape. AC= AVC. AFC must always fall as output increases, and its component
(in AC) tends to gradually shrink with increase in output.
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Thus, initially both AFC and AVC tend to fall. According, AC (which is the sum aggregate of
AFC and AVC) also falls. Subsequently, AFC tends to be a very small component of AC. So
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that, even when it is falling, it causes little impact on the rising AC (owing to rising AVC).
Hence, the final conclusion that AC (along with AVC) tends to be U-shaped in accordance
with the law of variable proportions.
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Y A Cost
Cost
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x
Output
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39. Identify the following as Fixed and Variable Cost.

a) License fee- Fixed Cost
b) Transport expenses – Variable Cost
c) Minimum electricity bill – Fixed Cost
d) Depreciation charges – Fixed Cost
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 e) Wages to permanent staff – Fixed Cost
f) Cost of Fuel- Variable Cost
Section B
Each question carries 3/ 4 marks:
40. Given the Total Fixed Cost is Rs.30, complete the following table:
Output(Units) AVC(Rs.) TVC=AVC. Q TC(TVC MC(TVCn-
+TFC) TVCn-1)

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1 20 20 50 20
2 15 30 60 10

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3 20 60 90 30

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41. Given below is the cost schedule of a firm. Its AFC is Rs.20 when it produces 3 units.

1 2H
Calculate its Marginal and Total Cost at each given level of output.
Output (units) 3
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AVC ( Rs.) 30 28 32
TVC( AVC . Q ) 30 56 96
AFC (TFC/Q) 60 30 20
TFC ( AFC . Q ) 60 60 60
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TC ( TVC +TFC) 90 116 156

MC(TVCn- 30 26 40
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TVCn-1)

42. A Firms average fixed cost of producing 2 units of a good is Rs. 9 and given below is its
total cost schedule. Calculate its average variable cost and marginal cost for each of the
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given level of output.

Output (units) 1 2 3
TC 23 27 30
AFC 18 9 6
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TFC(AFC .Q) 18 18 18
TVC( TC –TFC) 5 9 12
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AVC (TVC/Q) 5 4.5 4

MC(TVCn – 5 4 3
TVCn-1)

43. Calculate MC at each level of output:

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 Output ( Units) 1 2 3
TC ( Rs ) 80 96 120
AFC ( Rs) 60 30 20
MC (TVCn – 20 16 24
TVCn-1)
TFC(AFC.Q) 60 60 60

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TVC ( TC –TFC) 20 36 60
AVC (TVC/Q) 20 18 20

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44. Calculate TVC and TC from the following Schedule with Fixed Costs as Rs. 10.

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Output (units) 1 2 3 4
MC (Rs.) 6 5 4 6
TFC (GIVEN) 10 10
H 10 10
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TC 16 21 25 31
TVC(TC-TFC) 6 11 15 21

45. Complete the following table:

Output (units) AFC AVC TVC MC AC TC
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1 120 40 40 40 160 160

2 60 56 112 72 116 232
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3 40 54 162 50 94 282
4 30 54 216 54 84 336

46. When the total fixed cost of producing 100 units is Rs.30 and the average variable cost Rs.3,
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total cost is: (Choose the correct alternative)

a) Rs. 3
b) Rs. 30
c) Rs. 270
d) Rs. 330
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47. Show with the help of a numerical example that average cost is constant when marginal cost
is equal to it.
Units of output Total cost Average Cost Marginal cost
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0 14 - -
1 20 20 10
2 28 14 8
3 34 11.3 6
4 38 9.5 4

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 5 42 8.4 4
6 48 8 6
7 56 8 8
8 72 9 16
When AC does not change MC=AC, It happens when falling AC reaches its lowest point .At
the 7th unit AC does not change .it sticks to its minimum level of Rs, 8 . Here MC is also 8
48. Comment on the following statement “in the short run, a firm total cost will be zero if
the firm chooses to produce nothing.”

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This statement is false because in the short run, even at zero level of output, there exists some
fixed cost although the variable cost is zero. Hence, a firm’s total cost cannot be zero even if

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the firm chooses to produce nothing.
TC = TFC+TVC

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Section D
Each question carries 3 marks:

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49. A firm withdraws Rs.10000 from its fixed deposits with the bank and uses the money
for the purchase of factory equipment. Find the cost of this investment.
SC
Withdrawal of funds from the deposit for the purchase of a factory equipment involves an
element of explicit cost which is equal to the price of factory equipment
It involves an element of implicit cost equal to the loss of interest on the funds withdrawn
from the bank.
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DA
PO
N
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