Question

Chapter 11

1) What is the difference between the short run and the long run?

2) What is the law of diminishing returns? Why is this proposition called a "law"?

3) What are the two components of a firm's total cost in the short run, and what are their definitions?

4) What is the difference between average total cost and marginal cost and are they ever equal to each other?

Answer 1

1) Short run and long run is for cost of firm. Short run is the period of time during which production can be increased only by increasing variable factors. Fixed factor like plant and machinery remains constant. The producer can control only the variable costs not the fixed cost. Accordingly, the producer must cover at least variable costs of production during the short period.

Long period is he period of time during which production can be increased by way of additional application of all the factors of production. The producer must cover all costs of production. In fact all costs are of the nature of variable costs in the long run because no factor is a fixed factor in the long run. All costs are under the control of the producer, and therefore must be covered.

2) Law of diminishing returns states that as more and more of the variable factor is combined with the fixed factor, a stage must ultimately come when marginal product of the variable factor starts declining.

3) Two components of firm's total cost are Total Fixed Cost and Total Variable Cost.

(i) Total Fixed costs are the sum total of expenditure incurred by the producer on the purchase or hiring of fixed factors of production. These are also called supplementary costs, or overhead costs or indirect costs. These costs do not change with the change in output.

Units of Output	Total Fixed Cost (TFC)
0	10
1	10
2	10
3	10
4	10
5	10
6	10

(ii) Total Variable Cost: Variable costs are the expenditure incurred by the producer in the use of variable factors of production. When output changes, these costs also change. As the output increases, these costs also increase and vice-versa. These costs are called Prime costs or Direct costs. Variable costs include expenses like Purchase of raw material, wages of casual labor, expenses on expenditure.

4)

Average Total Cost: Cost per unit of output is called Average cost. It is also called unit cost of production.

ATC = TC/Q

here, ATC = Average Total Cost

TC = Total Cost

Q = Quantity of Output

Marginal Cost: It is the additional cost which is incurred by the producer to produce an additional unit of commodity.

MC = Change in TC / Change in Q