Question 1(a):
It is important for distinguishing between explicit and implicit cost because if the implicit costs are not identified in addition to explicit costs, then an overallocation of the resources could be resulted (Kesavan & Elanchezian, 2005). Implicit and explicit costs are both very important for economists and accountants alike in order to understand the true economic or opportunity cost of production (the cost of trading between different resources).
Question 1(b):
A: Nike’s advertising expenses are considered to be explicit costs because they are easily identified, recorded and audited. Explicit costs and the monetary transactions that can result in real business opportunities and are the accosting costs that are directly linked to company’s business activities (Diwedi, 2015).
B: Jim’s fuel cost is also considered to be explicit cost because these are accounting costs and are directly linked to company’s business activities. So 5000 will be an explicit cost.
C: The interest paid on the capital is considered to be explicit cost as it is a direct out of pocket expense. This is explicit because it falls under actual or business costs that can be entered in the book of accounts (Diwedi, 2015).
D: Executive salary amount of 200 mn by Rio Tinto is also considered to be explicit cost because it is recordable, identifiable and has a monetary value. It is the expense that can be actually entered in the book of accounts (Diwedi, 2015).
Question 2 (A):
The decreasing MPL (marginal product of labor) occurs due to diminishing return on labor. This means that the total output increases at a decreasing rate. In this case, marginal cost will rise with increase in output (Hubbard & O'Brien, 2001). Eventually, the rise in marginal cost will also lead to increase in average total cost. The example below reveals the concept more clearly:
- Assuming that the wage rate is $10 and an extra worker would cost $10.
- The MC of the bottle will be cost of labor divided by the number of extra bottles produced.
- MP of labor will increase but MC will fall, when MP of labor decrease, the MC will rise.
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Labor
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MP ($)
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TP ($)
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MC ($20/MP)
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|
1
|
2
|
2
|
10
|
|
2
|
4
|
6
|
5
|
|
3
|
6
|
12
|
3.3
|
|
4
|
8
|
20
|
2.4
|
|
5
|
10
|
38
|
2
|
|
6
|
8
|
38
|
2.4
|
|
7
|
5
|
43
|
4
|
In the example above, when the first labor is added, the worker’s cost is $20 whereas the MC of two units produced is $10.
- At 3rd worker, the MC is $3.3 (20/6).
- At 5th worker, the MC is only $ 2(20/5). This is where the MC is minimum with maximum MR of Labor. After this point, the law of diminishing returns will start as adding more labor would not add to productivity but reduce the productivity and increase MC of labor.
- At 7th worker, the MC has risen again to $4 (20/5). Here the returns are diminishing while the marginal cost of producing extra bottles has risen to $4. Hence, with decreasing MP of Labor, the MC will increase and MR will decrease. It is because the place will become too clogged up and adding one more worker will only increase the associated costs instead of profits(Hubbard & O'Brien, 2001).
Question 2(B):
The increase in marginal cost will lead to increase in total average cost. When MC rises, the total average cost also rises. When the MC and MR are equal to each other, the company earns maximum profit (Manand, 2009). If price charged by the firm is more than its average total cost, then the company would earn profits. Conversely, if the price charged by firm is lower than its average total cost, it will incur losses. Hence three points can be highlighted: when price is equal to ATC, the firm will earn zero profit, when the price is more than ATC, the firm will earn economic profit and when the price is lower than ATC, the firm will incur losses (Mandal, 2007).
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Question 3:
- A) A price maker is the business firm that has full control over the price and can influence the price in market(Sexton, 2012). It is the single seller in a market. It determines the price level and then set the output level at which greatest profits could be yielded. Since the monopolist is a single market supplier, its demand curve is equal to the market demand curve and is downward sloping. The reason that the demand curve of a monopolist firm is inelastic as compared to the demand curve of monopolistic market is because monopolist has more control over the price that it can charge for its output(Sexton, 2012). Due to having lesser power over price, the monopolistically competitive firm has relatively elastic demand curve. The control over price in monopolistic market is dependent on the degree of differentiation of products from competing firms.
- B) A normal profit is the profit attained after considering both explicit and implicit costs. It is also viewed as economic profit and occurs when there is zero difference between company’s total revenue and combined explicit and implicit costs. Normal profit earning is important for firms because it is the minimum amount that can justify the existence of firm in the industry for long run. It is the minimum amount of earning needed to justify the business entity’s survival(Arnold, 2008).
- C) The perfectly competitive market is highly unlikely to exist in the world because of its assumptions like homogeneous products, price-takers, small market share, full information by buyers and freedom of entry & exit. In reality, most of the products in any industry have some degree of differentiation(Hubbard & O'Brien, 2001). Even when it comes to selling bottled water, the producers tend to differentiate their bottled water in terms of purity, mineral contents etc. Similarly, many industries have barriers to entry like startup costs and government regulations. Moreover, the full knowledge and awareness of consumers is another hypothetical assumption of perfectly competitive market as consumers might have lacking information. Agriculture industry can be considered closest to perfect competition yet the assumption of no barriers to entry fails in it too(Arnold, 2008).
- D) The shares market closely reflects the perfectly competitive market because it fulfills the following assumptions of it(Hirschey, 2008);
- 1000s of buyers and sellers are trading through different brokers in the market.
- All brokers and traders have equal access to updated information.
- Consumers are free to check in different prices of brokers and can make decisions easily.
- The shares that are traded in the market are homogeneous and it doesn’t matter that shares are being brought from which brokers.
- There are virtually few barriers to entry or exit in market. The only barrier is money and regulations of stock market. Yet, the barriers to entry are non-insurmountable for companies.
- The concept of rationality is present there as people trade there for maximizing their profits.
Question 4:
If Frank is at position where its Total Revenue is below its Average Total Cost, then it is making economic losses. It will be the point where Frank needs to determine whether its output level is produced at point where its price is equal to marginal revenue and marginal cost or not or it would have to shutdown. The key criterion for shutting down is when the price is lower than AVC and TR is less than both ATC and TC. Frank can minimize losses by stop producing an output in the short run as it is not receiving enough revenue to even cover its average variable cost let alone its fixed cost. The following cases have to be considered by Frank for making decision at MR=MC;
- If it’s MR=MC and P>AVC but P<ATC, then it can continue to produce in short run and make economic losses(Mandal, 2007).
- If it’s MR=MC and P<AVC then Frank should incur only fixed cost and shutdown its café(Manand, 2009).
Question 5:
The firms must choose different output levels for deciding the output and price where it would maximize its profit. The profit maximization rule suggests that the manufacturers earn maximum profit where the marginal costs are equal to marginal revenues and the marginal cost curve is rising i.e. (MC=MR) (Hubbard & O'Brien, 2001). The MR is the change in total revenue and MC is the change in total cost if one more unit of good is produced and sold. MR is also known as the slope of total revenue (Hubbard & O'Brien, 2001). The graph below shows the profit maximization point and the reason for it:
At point A, the MC < MR that means revenues will be higher than the cost for each additional unit produced. At B, the MC > MR that means the cost will be higher for each additional unit produce.
Question 6:
- A) Frank is operating in an oligopoly market as it is the one where the industry is dominated by few large firms rather than a large number of smaller firms(Griffiths & Ison, 2001). In café industry, the firms are offering standardized yet differentiated products with slight degree of price making power. With high entry obstacles and differentiated products, Frank is operating in an oligopoly market.
- B) Oligopolies can thwart competition and can easily restrict the outputs for maximizing profits. Hence, for Frank, it is suggested to produce only until its MC = MR(Griffiths & Ison, 2001). It is possible that Frank will be facing a kinked-demand curve because of the competition from other oligopolists in the market.
Figure 1: Kinked Demand Curve Oligopoly
Source: (Griffiths & Ison, 2001)
The figure shows that the profit will be equivalent to the area “a b c d” at price P and quantity Q. At this point, Frank will be equating its MR = MC. If it tends to increase price above P, the other cafes wouldn’t follow the rise and Frank will face more elastic demand curve named as MD1. At MD1, people will demand lower products by Franks café due to its higher price and go to other cafes. Here, the demand for Franks café would become elastic. At price below P, Franks demand curve will become less elastic as MD2 as other competitors will also reduce their prices for following Frank. When oligopolists will follow Frank, the market demand curve will become less elastic.
Question 7:
Game theory in economics is the theory that considers the interaction between different participants and their behaviors related to strategic decision making in a strategic setting (LiveEcon, 2007). It studies the rational behavior in strategic situation involving interdependence of individuals. In my life, I’ve used game theory in many situations as a strategic interaction between me and my partner for arriving at a decision. It helped me finding the best course of action, following my opponents/partner’s choice. The matrix below represents the game theory I used:
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|
Partner Agrees on Friendship
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Partner Stays Silent
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|
I Ask for Friendship
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Long-term Relationship Starts
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You Feel Rejected
|
|
I Stay Silent
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Partner Feels Rejected
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Dominant Strategy Where Dignity Remained Intact for Both
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In first scenario, it was a win-win situation where we both would agree for friendship. In second scenario, I would’ve risked my dignity and become vulnerable for feeling rejected. In third scenario, if I stayed silent over friendship request by partner, he/she would’ve felt rejected. Well the fourth one is best of all where both of us remained silent and didn’t approach for friendship hence the dignity remained intact. The game theory never necessarily yields the best possible outcome, but generates a logical one. The dominant strategy is where no one has to face loss.
Works Cited
Arnold, R. A. (2008). Microeconomics. Cengage Learning.
Diwedi, D. N. (2015). Managerial Economics (8th ed.). Noida: Vikas Publishing House.
Griffiths, A., & Ison, S. (2001). Business Economics. Heinemann.
Hirschey, M. (2008). Fundamentals of Managerial Economics. Cengage Learning.
Hubbard, G. R., & O'Brien, A. P. (2001). Microeconomics. Pearson Education India.
Kesavan, R., & Elanchezian, C. (2005). Engineering Economics and Financial Accounting. Firewall Media.
LiveEcon. (2007). Microeconomics . Interactyx Ltd.
Manand, A. T. (2009). Managerial Economics. Noida: Excel Books India.
Mandal, R. K. (2007). Microeconomic Theory. Atlantic Publishers & Dist.
Sexton, R. L. (2012). Exploring Economics (6th ed.). Cengage Learning.
