NAME : BILAL AHMED

ARID NO:19-ARID-5296
 SECTION 1

Q1: Define marginal cost. Why does marginal cost eventually increase as total product
      increases?
ANSWER:
A firm’s marginal cost is the change in total cost that results from a one-unit increase in total
product. Marginal cost tells us how total cost changes as total product changes. Marginal cost is
defined as the change in total cost as one more unit of output is produced. It eventually declines
in the short run as a result of decreasing marginal product of labor.

Marginal cost is the additional cost incurred in the production of one more unit of a good or
service. It is derived from the variable cost of production, given that fixed costs do not change as
output changes, hence no additional fixed cost is incurred in producing another unit of a good or
service once production has already started. Marginal cost will tend to fall at first, but quickly
rise as marginal returns to the variable factor inputs will start to diminish, which makes the
marginal factors more expensive to employ. This is referred to as the ‘law of diminishing
marginal returns’ .Marginal cost is significant in economic theory because a profit maximizing
firm will produce up to the point where marginal cost (MC) equals marginal revenue (MR).

Q2: What is the relationship between the long-run average cost curve and the short-run
      average cost curves? What do economies of scale and dis economies of scale have on the
      shape of the long-run average cost curve?
ANSWER:

The relationship between these two curves is that a long run average cost curve consists of
several short run average cost curves, each of which refers to a particular scale of operation. both
curves are u shaped the short run avg cost curve rising because of labor specialization and better
spreading of fixed costs and it rises due to the law of diminishing returns. The long run avg cost
curve falls because of economies of scale and rises because of dis-economies. The long run avg
cost curve must comprise of all the lowest points of each of the short run avg cost curve because
no firm will operate at a level of higher costs in the long run than in the short run. The long run
avg cost curve must always be equal to or lie below any short run avg cost curve because in the
long run all factors of production can be variable.
Q3: What are the two main differences between the short-run and long-run? Why does
     diminishing marginal product exist in the short-run, but not the long run?

The main difference between long run and short run costs is that there are no fixed factors in
the long run; there are both fixed and variable factors in the short run. In the long run the
general price level, contractual wages, and expectations adjust fully to the state of the economy
In long - run, optimal size of the firm is realized when average cost is at the minimum point. The
minimum point depicts the most efficient level of operation beyond which the firm begins to
experience dis-economies of scale. In the short run, at least one of the inputs is fixed in quantity.
In the long run, all inputs can be varied in number. In the SR, since you have a fixed amount of
an input (usually Capital) and variable labor, you have diminishing marginal product of labor
occur at some point. In the long run, you can avoid diminishing marginal product of labor by
adding more capital.

Q4: Why is marginal revenue equal to both average revenue and price in a perfectly
     competitive setting?
There are some basic assumptions to be satisfied in order to consider a market as a perfectly
competitive market. One of them is that no firm can decide or influence the market price of a
good by changing its quantity. It implies that you need to treat price as constant while
performing any mathematical operations in case of perfect competition.
. If the price is constant (say $5), then the next unit you sell will be at $5 (so, MR=$5). Also, if
all units are sold at $5, then the average is $5 (Average Revenue=$5)

Q5: Why can't a perfectly competitive firm influence industry price?

Price is determined by the intersection of market demand and market supply; individual firms do
not have any influence on the market price in perfect competition. Once the market price has
been determined by market supply and demand forces, individual firms become price takers, Too
many small firms with little market share selling homogeneous goods.

Q6: How can the shape of a firm's long-run average cost curve determine the optimal size
     of the firm?

In long - run, optimal size of the firm is realized when average cost is at the minimum point. The
minimum point depicts the most efficient level of operation beyond which the firm begins to
experience dis-economies of scale. Firms do not want to operate on the decreasing returns to
scale portion of the LRAC. If the DRS occurs at a low output quantity, then firms will stay small.
However, if DRS doesn’t occur until a much higher output , then firms will be bigger.

SECTION II
Q1: Jennifer's Carpet Cleaners has fixed costs of $100 per month and a total cost curve
      as given in the table below. Output is the number of carpets cleaned. Given this data,
      answer the questions below.

Part a:

Q            TC            MC          TR         MR
0             100            -               -             -
10           200           10            180         18
20           320           12            360         18
30           460           14            540         18
40           620           16            720         18
50           800           18            900         18
60          1,000         20            1,080      18    

Profit maximizing output is 50 carpets

Profit = $100

Part b :

Q            TC            MC          TR         MR
0             100            -               -             -
10           200           10            140         14
20           320           12            280         14
30           460           14            420         14
40           620           16            560         14
50           800           18            700          14
60          1,000         20            840         14  

Profit maximizing output = 30 carpets

Loss = $40
Question 2: For each of the following two situations, determine: i) Profit-maximizing
output level,
      and ii) total profits

Part I Fixed costs = $40,000; price = $600

Q              TC               MC              TR              MR
0             40,000            -                   0                  -
100         80,000            400            60,000          600
200        120,000           400            120,000        600
300         170,000          500            180,000         600
400         230,000          600             240,000        600
500         300,000          700             300,000        600
600         380,000          800             360,000        600
700         470,000          900             420,000        600

Profit maximizing output = 400

Profit = $10,000

Part II Fixed Costs = $0; price = $80

Q          TC             MC           TR          MR
1           40              40              80           80
2           90              50              160         80
3          150             60              240         80
4          210             60              320         80
5          280             70               400        80
6          360             80               480        80
7          450             90               560         80
8           550            100             640         80

Profit maximizing output = 6

Profit = 120