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In: Economics

This is from "Microeconomics" subject WRITE SHORT ESSAYS OF 250 - 500 words. 3.WHAT ARE ECONOMIC...

This is from "Microeconomics" subject

WRITE SHORT ESSAYS OF 250 - 500 words.

3.WHAT ARE ECONOMIC COSTS AND ECONOMIC PROFITS FOR A BUSINESS?

Q4. WHAT ARE SHORT RUN COSTS AND IF YOU HAD YOUR OWN BUSINESS, HOW WOULD YOU CONTROL THEM?

Solutions

Expert Solution

Firstly I would like to explain the meaning of microeconomics in detail with example.

Microeconomics is that part of economic theory which deals with the behaviour of individual units of an economy such as a household, a firm, etc.

It is the analysis of economy’s constituent elements—households, firms and industries. Micro is a Greek word meaning ‘small’. Thus, microeconomics means economics of small.

In simple words we can say,

Microeconomics is the study of individuals, households and firms' behavior in decision making and allocation of resources. It generally applies to markets of goods and services and deals with individual and economic issues.

Purpose

One goal of microeconomics is to analyze the market mechanisms that establish relative prices among goods and services and allocate limited resources among alternative uses. Microeconomics shows conditions under which free markets lead to desirable allocations. It also analyzes market failure, where markets fail to produce efficient results.

The main key role of Microeconomics is to examine how a company could maximize its production and capacity, so that it could lower prices and better compete in its industry.

Q3. Economic cost with example

Economic cost is the accounting cost (explicit cost) plus the opportunity cost (implicit cost). Implicit cost refers to the monetary value of what a company foregoes because of a choice it made.

Rather than explaining it , I will simply give an example, both term will clear to you.

Suppose you work at a MNC. One day you get bored and decide to start a venture. (Possibly a Deja vu for many guys who have a hobby thinking about startups with tea in the evening). Now you work out all the expenses you'll have to make to do so. Lets keep it simple. You want to start a venture dealing in a trivial product like a software.

So let's say you require a laptop, an engineer and a miscellaneous guy for the odd jobs.

So let's calculate your costs here : let's say 30000 for the laptop, 40000 as the engineer's salary and 20000 to the third guy( I am being generous to him.) So an accountant would calculate your costs as 30,000+40,000+20,000= 90,000. Is that all. Just think about it. If you can afford this , will you surely start this venture. What if your venture gives you a profit of say 5000 only. Won't you think I was better working for the MNC earlier. While calculating economic costs you feature that in. This is called as opportunity cost( the money you could have earned if you wouldn't have started this venture).

So the economic costs would include 90000(the accountant's cost ) + the opportunity cost( which is your salary here, since you can always earn this much if you decide to quit the company) . So in a way you have considered everything that holds pertinance. Any project with a positive economic profit( revenue - economic costs) is worth starting, which is not the case for all projects with positive accountant profit( revenue- accountant cost). A project with a positive accountant profit but a negative economic profit means that although you are making some money with your venture, you would have been better off working for the MNC. An economic profit of zero means that you are equally well off working for the company or the venture. It does not mean that you earn nothing. So a 0 economic profit is normal and is certainly the case in perfect competition.A positive economic profit means that you are earning more than you could have if you remained in the MNC. Whereas 0 accountant profit means that you earn nothing and must move to something else. A negative accountant profit means that you are spending from your own pocket , not earning.

Economic profit with example

An economic profit or loss is the difference between the revenue received from the sale of an output and the costs of all inputs used, as well as any opportunity costs. In calculating economic profit, opportunity costs and explicit costs are deducted from revenues earned

For example, assume a company needs to make significant changes in their business model in order to survive in the market and beat the competition. After a review of their business model, the manager suggests that the company can survive if it adopts either of two feasible options: cost-cutting or the introduction of new product lines.

Management decides to go forward with cost-cutting. In such a case, the potential earnings that could be generated by introducing a new product are given up in exchange for the increased profits realized by cutting costs. Choosing not to pursue developing new product lines represents a lost opportunity. Hopefully, the company has done careful cost-benefit analysis and discovered that the largest potential profit increase will be derived from reducing operating costs.

Q4. Short Run Cost is the cost price which has short-term inferences in the manufacturing procedures, i.e., these are utilised over a short degree of end results.

In simple words we can say

Short run cost refers to a certain period of time where at least one input is fixed while others are variable.

In the short-run period, an organisation cannot change the fixed factors of production, such as capital, factory buildings, plant and equipment, etc. However, the variable costs, such as raw material, employee wages, etc., change with the level of output.

Business firms aim at producing the product at the minimum cost. It is necessary in order to achieve the goal of profit maximisation. The success of financial management is judged by the action of the business executives in controlling the cost. This has led to the emergence of cost accounting systems.

How to control or minimize the Short-Run Cost

LO: Describe the solution to the cost minimization problem in the short run.

In order to maximize profits firms must minimize cost. Cost minimization simply implies that firms are maximizing their productivity or using the lowest cost amount of inputs to produce a specific output. In the short run firms have fixed inputs, like capital, giving them less flexibility than in the long run. This lack of flexibility in the choice of inputs tends to result in higher costs.

In Module 6, we studied the short-run production function:

q=f(L,¯¯¯¯¯K)q=f(L,K¯)

Where q is output, L is the labor input and K̅ is capital. The bar over K indicates that it is a fixed input. The short-run cost minimization problem is straightforward: since the only adjustable input is labor, the solution to the problem is to employ just enough labor to produce a given level of output.

Figure 7.2.1 illustrates the solution to the short-run cost minimization problem. Since capital is fixed, the decision about labor is to choose the amount which, combined with the available capital, enables the firm to produce the desired level of output given by the isoquant.

Figure 7.2.1: Short-Run Cost Minimization

From Figure 7.2.1 it is clear that the only cost minimizing level of the variable input, labor, is at L*. To see this, note that any level of labor below L* would yield a lower level of output, and any level of labor above L* would yield the desired level of output but would be more costly than L* because each additional unit of labor employed must be paid for.

Mathematically this problem requires only that we solve following production function for L:

q=f(¯¯¯¯¯K,L)q=f(K¯,L)

Solving the production function requires that we invert it, which we can do only if the function is monotonic. This requirement is satisfied for our production functions because we assume that output always increases when inputs increase.

L∗=f−1(¯¯¯¯¯K,q)L∗=f−1(K¯,q)

Let’s consider a specific example of a Cobb-Douglas type production function:

q=10¯¯¯¯¯K12L12q=10K¯12L12

To find the cost minimizing level of labor input, L*, we need to solve this equation for L*:

L12=(q10¯¯¯¯¯K12)2L12=(q10K¯12)2

This simplifies to:

L∗=q2100¯¯¯¯¯KL∗=q2100K¯

Note that this equation does not require a specific output target but rather gives us the cost minimizing level of labor for every level of output. We call this an input demand function: a function that describes the optimal factor input level for every possible level of output.

Hope this will help you ?


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