Question

7 what is the relationship between marginal cost and short-run supply curve explain using graphs.

8 using the concepts of producer and consumer surplus explain the welfare implications of major brought on producers and consumer

9 using the concepts of producer and consumer surplus explain the welfare implication of major drought on producers and consumers

Answer 1

7. The relation between marginal cost and short run supply is that, the marginal cost above the short run average variable cost is the supply curve of the firm. In the short run, there are variable cost and fixed cost, as against in the long run, where even the fixed cost are variable. The cost function seems as , where f(Q) is the variable cost, ie cost which varies as quantity Q is changed, and F is the constant fixed cost. The cost theory of the firm states that the profit maximizing quantity for the firm is where the marginal revenue is equal to the marginal cost, and where the marginal cost curve cuts the marginal revenue curve from below. The marginal cost is the most basic determinant in the production of profit maximizing quantity, as the marginal revenue is exogeneous, depends on the demand curve the firm faces.

The firm's supply changes as the demand poses different opportunities, ie as the marginal revenue changes. The changing marginal revenue will lead to change in quantities produced, and will be accordingly where the marginal revenue is equal to the marginal cost.

Suppose the cost of the firm is as given, . Then, the marginal cost, ie the cost to produce one extra quantity will be , ie or . Also, as the variable cost is , the average variable cost is hence . If the price is less than the AVC at any quantity, the firm will not be able to cover the variable costs such as labor, and will shut down. Hence, the production points, or the supply curve of the firm is where .

The graph below can show that. Suppose there is a hypothetical cost function as . The marginal cost is , and the average cost is , and the average variable cost is . The graph plot is as below.

The orrange MC curve, below the AVC, is not the supply curve, as at that price, the firm have to be closed down for not incurring even the variable cost. The red MC is the supply curve of the firm. Several supply curve are added so as to represent the industry supply curve.