1. Analyze the shape of the short-term production function.
The short-term production function shows the relationship
between the quantity of input used and the quantity of output
produced, holding other factors constant. Initially, the curve rises
steeply due to increasing marginal returns. However, after a
certain point, the curve flattens, indicating diminishing marginal
returns. Eventually, the curve may decline if the input becomes
overly congested or inefficient.
2. Explain the three stages of production.
Stage I (Increasing Returns to the Variable Factor): In this stage,
each additional unit of input increases output more than the
previous one. Marginal product (MP) is increasing, and average
product (AP) is rising.
Stage II (Diminishing Returns to the Variable Factor): Here,
marginal product begins to decrease, but output is still increasing.
AP starts to decrease as MP falls below it.
Stage III (Negative Returns): In this stage, adding more of the
variable input decreases total output, and both MP and AP are
negative. This is the inefficient stage of production.
3. At which stage will a rational producer produce?
A rational producer will produce in Stage II because, although
marginal returns are diminishing, the firm is still increasing output.
Producing beyond this stage would lead to a reduction in total
output.
4. Explain the relationship between AP and MP.
When MP > AP, average product (AP) is rising.
When MP = AP, average product is at its maximum.
When MP < AP, average product is falling. Thus, the marginal
product curve intersects the average product curve at its maximum
point.
5. Explain the relationship between MC, AC, and AVC.
MC (Marginal Cost) is the change in total cost when
producing an additional unit of output.
AC (Average Cost) is the total cost divided by the quantity of
output, and it is U-shaped.
AVC (Average Variable Cost) is the variable cost per unit of
output and is also U-shaped.
The MC curve intersects both the AC and AVC curves at
their lowest points. When MC is below AC or AVC, both
average costs are falling, and when MC is above, both are
rising.
6. What is an expansion path? How does a change in the
price of one input change the firm’s long-run expansion
path?
An expansion path is a curve that shows the optimal
combination of inputs for different levels of output in the
long run. A change in the price of one input shifts the
expansion path. If the price of a factor decreases, the firm
will use more of that input and less of others, shifting the
path. Conversely, an increase in the price will cause the firm
to reduce usage of that input.
7. Is the firm’s expansion path always a straight line?
No, the firm's expansion path is not always a straight line. It
depends on the production function and the relative prices of
inputs. If inputs are perfect substitutes, the expansion path
could be a straight line. However, if inputs are complementary
or exhibit diminishing marginal returns, the path may be
curved.
8. Explain the equilibrium condition of output and price
determination in a perfectly competitive market.
In a perfectly competitive market, equilibrium is achieved when
market supply equals market demand. The price is determined at
the intersection of the supply and demand curves. At this point,
firms in the market produce the quantity of output where
marginal cost (MC) equals marginal revenue (MR), which is also
equal to price (P).
9. Explain the equilibrium condition of output and price
determination in a monopoly market.
In a monopoly, the firm is the sole producer and sets the price.
The equilibrium condition occurs when marginal cost (MC) equals
marginal revenue (MR), but unlike in perfect competition, the
monopolist charges a price higher than the marginal cost, leading
to a deadweight loss. The monopolist maximizes profit by
producing the quantity where MR = MC and charging a price
corresponding to this quantity on the demand curve.
10. What are assumptions of a perfectly competitive market?
Explain the assumptions intuitively.
Many buyers and sellers: No single buyer or seller can influence the price.
Homogeneous products: All products are identical, so consumers have no
preference for one seller over another.
Free entry and exit: Firms can freely enter or leave the market without
significant barriers.
Perfect information: All consumers and producers have complete
knowledge about prices and products.
No government intervention: No taxes, subsidies, or regulations affect
the market.
These assumptions ensure that firms are price takers and that market
forces determine equilibrium.
11.“At equilibrium, a monopoly market produces lesser
output at a higher price compared to a perfectly competitive
market” – verify this argument with an appropriate
explanation.
In a monopoly, the firm maximizes profit by setting the price
higher than marginal cost (MC) and producing a lower
quantity of output. The monopolist faces a
downward-sloping demand curve, so to sell more, it must
lower the price. In contrast, in a perfectly competitive
market, firms produce at the point where price equals
marginal cost (P = MC), resulting in a higher quantity and
lower price. Therefore, the monopolist produces less and
charges a higher price than in perfect competition.
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