Question

9.   Answer each of the following as True or False.

     

      a.  A good Manager, i.e., one who wants to maximize profit or minimize loss, will not

           operate in Stage III of production.

      b.  In the market period, the supply curve is perfectly elastic.

      c.  When increasing returns to scale exist, long-run average cost increases as output

           increases.

      d.  The law of diminishing returns is relevant for the short-run.

      e.  Average fixed cost always decreases as output increases.

10.  a.  What is the difference between fixed proportions and variable proportions production?

       b.  What is the price elasticity of supply?

       c.  What does it mean if supply is price inelastic?

       d.  Why is supply more elastic in the long-run than the short-run?

Answer 1

9) a) True. A good manager who wants to maximize its profit and minimize its loss operates in Stage II of production. Although marginal product declines, additional employment of the variable input does add to total production. Even though production cost rises with additional employment, there are benefits to be gained from extra production. The trick is to balance the extra cost with the extra production. Firms can comfortably, and profitably, produce forever and ever in Stage II.

b) False. Since, market period is a very short interval of time, supply cannot change in this short time. Producers need time to adjust to the changes in the price of the commodity. Thus, in market period, the supply is perfectly inelastic.

c) False. When the firm is benefitting from increasing returns t to scale, there is a decrease in long run average cost as output increases. Increasing returns to scale arises within the firm from the firm’s production function. Increased output may allow a firm to use inputs more productively. If doubling all the firm’s input more than doubles output, there are increasing returns to scale. Moreover larger scale may also allow the more efficient use of inputs through specialization of tasks.

d) True. According to the law of diminishing returns, employing additional factors of production causes relatively smaller increase in outputs. It only applies in short run because in short run one factor is fixed (e.g., capital). If the capital is fixed, extra workers will eventually get in each other’s way as they attempt to increase in production.

e) True. Average fixed cost is the fixed cost of production divided by the quantity of output produced. As the total number of units of output increases, the average fixed cost decreases because the same amount of fixed cost is being spread over a larger number of units of output.

10) a) In a fixed proportions production process the vertical integration cannot increase profits, whereas with variable proportions profits can rise. In fixed proportion production function, there are fixed factors of production such as land, labor, raw materials. These fixed factors of production are used to produce a fixed quantity of output and these production factors cannot be substituted for other factors. Whereas, in variable proportion production function, factors of production such as land and capital are not fixed and it is variable. Here, different combination of factors can be used to produce the given quantity. Hence, one factor can be substituted for the other.

b) Price elasticity of supply measures the responsiveness to the supply of the goods and services after a change in its market price. According to basic economic theory, the supply of the goods will increase when the price rises and vice-versa.

Price elasticity of supply = % change in supply/%change in price

c) Supply is price inelatic if the change in price causes a smaller percentage change in supply. It is calculated by percentage change in supply divided by percentage change in price.

d) Over the short run, supply tends to be in inelastic, because of the limited options available to change supply. Over the long-run, supply becomes more elastic, because suppliers can take actions that take more time to increase the supply, such as building new factories, hire many new workers or open stores.