Assume the marginal cost of production is greater than the average variable cost. Can you determine whether the average variable cost is increasing or decreasing? Explain.

Duration: 70 minutes

Variant-A

Part-1 (75 points)

1. Suppose a firm must pay an annual tax, which is a fixed sum, independent of whether it produces any output.

a. How does this tax affect the firm’s fixed, marginal, and average costs?

b. Now suppose the firm is charged a tax that is proportional to the number of items it produces. Again, how does this tax affect the firm’s fixed, marginal, and average costs?

2. Suppose a chair manufacturer finds that the marginal rate of technical substitution of capital for labor in his production process is substantially greater than the ratio of the rental rate on machinery to the wage rate for assembly-line labor. How should he alter his use of capital and labor to minimize the cost of production?

3. Suppose a chair manufacturer is producing in the short run when equipment is fixed. The manufacturer knows that as the number of laborers used in the production process increases from 1 to 7 the number of chairs produced changes as follows: 10, 17, 22, 25,26,25,23.

a. Calculate the marginal and average product of labor for this production function.

b. Does this production function exhibit diminishing returns to labor? Explain.

c. Explain intuitively what might cause the marginal product of labor to become negative.

4. The short run cost function of a company is given by the equation TC= 200+55q, both TC and q are measured in thousands.

a. What is the company’s FC?

b. If the company produced 100000 units of goods, what is the average variable cost?

c. What is its marginal cost per unit produced?

d. What is its average fixed cost

e. Suppose the company borrows money and expands its factory. Its FC rises by $50000, but its variable cost falls to $45000 per 1000 units. The cost of interest also enters into the equation. Each one point increase in the interest rate raises costs by $3000. Write the new cost equation.

5. Suppose that a competitive firm’s marginal cost of producing output q is given by MC(q)= 3+2q. Assume that the market price of the firm’s product is $9.

a. What level of output will the firm produce?

b. What is the firm’s producer surplus?

c. Suppose that the average variable cost of the firm is given by AVC(q)= 3+q. Suppose that the firm’s FC are known to be $3. Will the firm be earning a positive, negative or zero economic profit in the short run?

Part–2. (25 points) (explain the following terms.)

1.Why are isocost lines straight lines?

Assume the marginal cost of production is greater than the average variable cost. Can you determine whether the average variable cost is increasing or decreasing? Explain.

3.Industry X is characterized by the perfect competition, so every firm in the industry is earning zero economic profit. If the product price falls, no firms can survive. Do you agree or disagree? Explain.

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

5. Can an isoquant ever slope upwards? Explain.

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