Question

1.  Suppose you are the Manager of a firm which employs both capital and unskilled labor and pays that labor the current Federal minimum wage of $7.25 per hour.  With the isoquant and isocost tools of economics explain the effects on your firm and/or what you would do when President Joe Biden (help us, Lord!) and his Democrat buddies in Congress increase the minimum wage to, say, $15 per hour.

2.  a.  What is the difference between economies of scale and returns to scale?

     b.  What is the major or most important reason for economies of scale?

     c.  Why is the law of diminishing returns important?

     d.  How would a decrease of capital affect a firm’s short-run production function?

3.  Suppose you are the new Manager of Kramerica Korporation, a firm which makes large rubber bladders for oil tankers with two inputs capital and labor.  On your first day, you discover that the marginal product of capital is 1,000, the price of capital or rent is $100, the marginal product of labor is 500 and the price of labor or the wage rate is $25.  Based on these numbers,

     a.  Is Kramerica employing its two inputs optimally?  How do you know?

     b.  What would you do as the new Manager, and why?  Be specific!

4.  Define the following concepts.

     a.  production function                                                                           f.  isoquant

     b.  short-run                                                                                             g.  isocost

     c.  long-run                                                                                               h.  technical efficiency

     d.  law of diminishing returns                                                               i.  economic efficiency

     e.  minimum efficient scale                                                                   j.  fixed cost

Answer 1

2.a. Returns to scale shows the response of total output to changes in all inputs by the same proportion. Whereas, economies of scale shows the effect of an increased output level on unit costs.

b. Economies of scale are the advantages that cause to a firm. It can be internal or external economies of scale.

Factors affecting economies of scale.

• Specialisation: individuals are assigned to concentrate on specific areas of job so that it improves quality of worker and also increases the quantity. Thereby reducing cost and increasing output.
• Negotiation: large scale firms can buy resources at a cheaper rate as they can negotiate easily on bulk purchases of raw materials.
• Technology: as large firms have better machines nad advanced technology with them, efficient utilisation of resources is possible.

Efficient capital: Large firms can afford to buy advanced machines which causes lower cost of production and benefit to their full capacity.

c. Law of dimishing returns is important because in production, it helps the firms to determine the optimum level of output and also it provides a balance in production within the organisation.

d. In short run capital is considered as fixed cost and labour as variable cost. So a increase or decrease in the capital causes the firm's shortrun production function shifts upward.

4. a. Production function: it is the transformation of factor inputs into outputs at any particular time period.

Y = f(L,K,R,S,V,r)

Where Y is output, K is capital, L is labour, R is raw material, S is land, V is returns to scale and r is efficiency parameter.

b. Isoquant: it shows all combination of the locus of points representing various combinations of two inputs yielding the same output.

c. Isocost: it shows all combination of factors that cost the same to employ.

d. Long-run: a relatively long period. It is a period of time in which all factors of production are variable.

e. Technical efficiency: it is the ability or effectiveness of a firm to produce a level of output with given input and technology.

f. Law of dimishing returns: it explains when more and more units of variable inputs are employed on a fixed quantity of inputs, the total output may initially increase at increasing rate and then at a constant rate, but will eventually increase at diminishing rates.

g. Economic efficiency: it indicates minimum cost for production of a good or service, maximum output and maximum surplus from the operation of the market.

h. Minimum efficient scale (MES): it is the lowest point on a long run average cost (LMAC) curve where a firm can operate efficiently and productively at the lowest possible unit cost.

i. Fixed cost: it is the predetermined cost or expenses that remainthe same throughout a specific period. They are also called as indirect cost or overhead costs.