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GROUP-3 IMPORTANT QUESTIONS
Producer’s behavior and supply
Q1. Explain the Law of variable proportion (Returns to an input)
(6)
Ans: It refers to the input-output relation when the output is increased by varying the quantity of one input, keeping the quantity of other factors
constant. The proportion between the factors is altered. Therefore, this law is known as law of variable proportion.
Assumption of the law: The law of variable proportion holds good under the following
conditions:
1. First, the state of technology is assumed to be given and unchanged.
2. Second, there must be some inputs whose quantity is kept constant.
3. Third, the law is based upon the possibility of varying the proportions in which the various
factors can be combined.
Three phases of the law of variable proportions.
The behavior of output can be divided into three phases as explained …….
Phase 1: Phase of increasing returns: Phase one ends where the AP reaches its highest point.
Thus during stage 1, whereas MP curve rises in a part and then falls and the AP curve reaches its
highest.
Phase 1 is known as the state of increasing returns because AP of the variable factor increases
throughout during this stage.
Phase 2 : Phase of diminishing returns:
In Phase 2, the total product continues to increase at a diminishing rate until it reaches to its
maximum point H where the second stage ends. At the end of the second stage, that is, at point
M marginal product of variable factor is zero. This phase is known as the stage of diminishing
returns as both the average and marginal products of the variable factor continuously fall during
this stage
Phase 3 : Phase of negative returns :
In this stage TP declines and therefore the TP curve steps downward. As a result, MP is negative
and MP curve goes beyond the X-axis.
Tabular presentation of the three stages of the law
Units
Of Total
Labour
Product
Marginal Product
Average Product
( Quintals )
(Quintals )
( Quintals )
1
8
8
8
2
17
9
8.50
3
29
12
9.67
4
39
10
9.75
5
45
6
9.00
6
45
0
7.50
7
43
-2
6.14
8
38
-5
4.75
PHASE 1
PHASE 2
PHASE 3
Causes of increasing return to a factor:
1. Indivisibility of the factors: Generally those factors are taken as fixed which are indivisible.
Therefore, when more and more units of the variable factor are added to the constant amount of
fixed factor, then fixed factor is more intensively and effectively utilized. This causes the
production to increase at a rapid rate.
2. Division of labour:The second reason is that as more units of the variable factor are employed
the efficiency of the variable factor itself increases.
Causes of diminishing returns:
Scarcity of fixed factor
Indivisibility of the fixed factor:
3. Imperfect substitutability of the factor:
Causes of negative returns:
As the amount of the variable factor continues to be increased to the constant quantity of the
fixed factor the variable factor becomes too excessive relative to the fixed factor, so that the TP
falls instead of rising.
Q2. Explain producer’s equilibrium using marginal revenue and marginal cost approach.(6)
Ans:A producer / firm is said to be in equilibrium when he gets maximum production with given
level of inputs
Equilibrium of a producer
Tabular Presentation:
Price
(Rs)
Output
TR (Rs) TC
MC
MR
Profit
(Units)
(Rs
(Rs)
(Rs)
(TRTC)
10
1
10
10
10
10
0
MC=MR
10
2
20
18
8
10
2
MC<MR
10
3
30
24
6
10
6
MC<MR
10
4
40
34
10
10
6
Equilibrium
10
5
50
46
12
10
4
MC>MR
MR and MC approach -In general a firm's profit maximizing condition is MR = MC, But for a
competitive firm.
Condition:
MC=MR
After Equilibrium output MC>MR
MC should be rising.
P = MC (Because in perfect competition P = AR = MR and MC is rising
Q 3. Whether statements are true or false? State reasons
(6)
1. As long as MC is rising, ATC will also rise.
2. At an output of one unit, ATC is equal to MC.
3. Total Revenue declines as long as Marginal Revenue is falling.
Ans:1. False, AC can fall even when MC is rising when MC < AC and MC rising.
2. False, at an output of one unit ATC is equal to TC and MC is less than ATC as MC is change
in TVC only.
3. False, Total Revenue rising at diminishing rate when MR is falling but is positive. TR falls
only when MR is negative.
Q4. Explain the effect of the following on the supply of a commodity:
(6)
(a) Fall in the prices of factor inputs.
(b) Rise in the prices of other commodities
Ans:When the prices of factor inputs decreases, the cost of production decreases. Thus, it
becomes more profitable to produce the commodity and so its supply will increase.
When the prices of other goods rise, it becomes relatively more profitable to produce these goods
in comparison to the given good. This results in diversion of resources from the production of
given good to other goods. So, the supply of the given good decreases.
Q5. On the basis of the information given below, determine the level of output at which the
producer will be in equilibrium.
(4)
Use the marginal cost – marginal revenue approach. Give reasons for your answer. Output
(Units)
Average Revenue (Rs)
Total Cost (Rs)
1
2
3
4
5
6
7
7
7
7
7
7
8
15
21
26
33
41
Ans:
Output
AR
TC
MC
MR
1
7
8
8
7
2
7
15
7
7
3
7
21
6
7
4
7
26
5
7
5
7
33
7
7
6
7
41
8
7
The producer achieves equilibrium at 5 units of output. It is because this level of output satisfies
both the conditions of producer’s equilibrium:
Marginal cost is equal to marginal revenue.
Marginal cost becomes greater than MR after this level of output.
Q6. Explain the relation between TC, TFC and TVC.
(4)
Ans: Relation between TC, TFC and TVC
1. TFC is horizontal to x axis.
2. TC and TVC are inverse S shaped (they rise initially at a decreasing rate, then at a
constant rate & finally at an increasing rate) due to law of variable proportions.
3. At zero level of output TC is equal to TFC.
4. TC and TVC curves parallel to each other.
TC
TVC
Cost
Y
TFC
O

TC=TFC + TVC

TFC=TC-TVC

TVC=TC-TFC
X
Output
Q7. Why does the difference between Average Total Cost and Average Variable Cost decrease
with an increase in the level of output? Can these two be equal at some level of output? Explain.
(4)
Ans:Average Total Cost (ATC) minus Average Variable Cost (AVC) is equal to Average Fixed
Cost (AFC). AFC = TFC / Output. As the level of output increases, AFC falls.
So, the difference between ATC and AVC decreases with increase in output.
ATC and AVC can never be equal at any level of output as AFC can never be zero because TFC
is positive.
Q 8. Explain the relation between marginal revenue and average revenue when a firm is able to
sell more quantity of output.
(4)
(i) at the same price.
(ii) only by lowering the price
Ans:(i) Price is constant. As price means average revenue, so average revenue is also
constant. Average revenue is constant only when marginal revenue is equal to
average revenue. Thus, when a firm is able to sell more quantity of output at the
same price marginal revenue is equal to average revenue.
(ii) If more can be sold only by lowering the price, it means that average revenue falls as more is
sold. Average revenue falls only when marginal revenue is less
than average revenue. Thus, when a firm is able to sell more quantity by
lowering the price, marginal revenue will be less than the average revenue.
Q9. Explain the relation between AC and MC.
(4)
Ans: Relationship between AC and MC





Both AC & MC are derived from TC
Both AC & MC are “U” shaped (Law of variable proportion)
When AC is falling MC also falls & lies below AC curve.
When AC is rising MC also rises & lies above AC
MC cuts AC at its minimum where MC = AC
Q10.Explain the relationship between AR and MR under monopoly and monopolistic
competition.(4)
Ans: Relationships between AR and MR under monopoly and monopolistic competition (Price
changes or under imperfect competition)
 AR and MR curves will be downward sloping in both the market forms.
 AR lies above MR.
 AR can never be negative.
 AR curve is less elastic in monopoly market form because of no substitutes.
 AR curve is more elastic in monopolistic market because of the presence of substitutes.
Q11.Complete the following table
(4)
Output units
Average Total Cost
Average Variable Marginal Cost
Cost
1
2
3
4
5
54
33
-
30
24
-






Ans:
Output units
1
2
3
4
5
ATC
54
36
32
33
38.4
AVC
30
24
24
27
33.6
30
24
60
MC
30
18
24
36
60
Q12. State the distinction between explicit cost and implicit cost. Give an example of each.(4)
Explicit cost is the actual monetary expenditure on inputs, like expenditure on
purchases of raw materials, on payment of wages, interest, rent, etc.
Implicit cost is the estimated value of inputs supplied by the owner of the firm, like
imputed salaries of the owners, imputed rent of the building of the owners, imputed
interest on the money invested by the owners, etc.
Q13. State t he ‘law o f su ppl y’ . What is m e ant b y the assum pt i on ‘ot her things
remaining the same’ on which the law is based? (3)
Ans:According to the law there is a direct relation between price of the good and its supply,
other things remaining the same. Other things include all factors, other than the own
price, which can influence supply, like prices of inputs, taxes on production, prices of other
goods, etc.
Q14. Differentiate between TVC& TFC
(3)
Ans: Difference between TVC & TFC
Basis
Meaning
Time period
Cost at zero
output
Factors
of
production
Shape of the
cost curve
TVC
Vary with the level of output
Can be changed in short period
Zero
TFC
Do not vary with the level of output
Remain fixed in short period
Can never be zero
Cost incurred on all variable Cost incurred on fixed factors of
factors
production
Upward sloping
Parallel to x axis
Q15. Explain relation between AR and MR in perfect competition.
(3)
Ans:Relationship between AR and MR (when price remains constant or perfect
competition)
Under perfect competition, the sellers are price takers. Single price prevails in the market.
Since all the goods are homogeneous and are sold at the same price AR = MR. As a result
AR and MR curve will be horizontal straight line parallel to OX axis. (When price is
constant or perfect competition)
y
Revenue
AR= MR=Price
x
o
OUTPUT
Q16.Differentiate between short run and long run production function.
(3)
Ans:Difference between short run & long run :
Basis
Short Run
Long Run
Meaning
Only variable factors are changed
All factors are changed
Price Determination
Demand is active.
Classification
Both demand & supply
play an important role.
Factors are classified as fixed & All factors are variable.
variable.
Q17. Price of commodity A is 10 per unit and total revenue at this price is 1600. When Its
price rises by 20 per cent, total revenue increases by 800. Calculate its Price elasticity of
supply.
(3)
Ans Initial Price = ₨ 10
New price P1 = P + ∆P
Initial TR= 1600
When P=10
When P1=12
P=10 P1=12
∆P =P1 – P=12-10=2
ES= 10/ 16 x 40/2 = 20/16 = 1.25
Rise in price ∆P= (20x10)/100 = 2
therefore 10 + 2 = 12
New TR= 1600+800=2400
Q=1600/10=160
Q1=2400/12=200
∆Q = Q1 - Q0 = 200 – 160 = 40
Q18. Calculate Total Variable Cost and Total Cost from the following cost schedule of a firm
whose fixed cost is Rs. 25.
(3)
Output Units
Marginal Cost(Rs)
Ans:
Output units
1
2
3
4
1
80
M.C.
80
60
40
65
2
60
3
40
4
65
TFC
25
25
25
25
TVC
80
140
180
245
TC
105
165
205
270
Q 19.State three relations between average variable cost and marginal cost.
Ans:
MC < AVC when AVC falls
MC = AVC when AVC is minimum
(3)
MC >AVC when AVC rises
Q20. Explain the behavior of TVC as output increases.
(3)
Ans:At zero level of output TVC will be zero. As output increases TVC increases at diminishing
rate due to increasing returns to factor. Then it increases at increasing rate due to diminishing
returns to factor.