Assignment Questions (Semester 1, 2012) Microeconomics – Worth 20% of total assessment: Answer all five (5) of the following questions. Each question is worth 10 marks. Question 1: Explain and...

Q1
The concept of marginal returns refers to the change in output when the input quantity is changed by 1 unit. It can be applied in the short and long run both.
Diminishing marginal returns applies in the short run when 1 factor is unchanged/fixed. Typically capital is fixed and labor is variable. It has been seen that as we increase labour the total output rises at a rising rate initially. Then it rises but at a diminishing rate, so that marginal product is positive but declining. Total output reaches a maximum level and then falls, so that marginal output becomes negative. This leads to the TP curve shown in top part of the figure below. Accordingly the AP (= TP/L) rises and reaches a maximum before it starts falling. Accordingly we have 3 stages of production. Diminishing return to a factor is the second stage where MP is falling. A rational firm will always operate in this range.
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Decreasing economies of scale are also called diseconomies of scale and operate in the long run. They operate when all factors of production are variable. They can be shown using the long run average cost curve (LAC). This curve has a U shape so that average costs decline as output rises. The decline continues till the curve reaches a minimum point; this is the most efficient point of production as average costs are minimised. Average costs start rising if output continues to rise. 1. This part of LAC curve shows that beyond a point as output rises, with all inputs variable the average costs will rise. When average costs start rising we refer to it as diseconomies of scale or decreasing economies of scale. Rising average costs can be traced to various reasons :
Managerial diseconomies in terms of problem of Control –it becomes tough to monitor workers and schedules of production as the scale of production rises. More managers are needed which raises costs of production. As output rises workers tend to shirk work and this causes loss of productive efficiency. Monitoring each worker within a large business is imperfect and costly.
Problem of Co-ordination – with increasing scale of production it is difficult to co-ordinate complicated production processes. Frequent
eak downs reduce efficiency and raise costs. To avoid these
eakdowns means hiring quality control people which is expensive and raises costs so that average costs tend to rise.
Lack of unity and Co-operation - Workers in large firms may feel alienated as the work force becomes large and new members are introduced. If the age difference in workers is large cooperation is tough as the perceived generation gap becomes an impediment to a united and collaborative atmosphere at work. Sometimes, ove
urdened and overworked labour causes efficiency to fall and this leads to mistakes that raise costs for the firm.
Q2
This is the kinked demand model in an oligopoly market structure. The main focus of the model is on the shape of the demand curve facing a firm. Unlike typical downward sloping curve this model has a kinked demand curve with a kink at price P*. The curve has two parts. The top part is flat; more elastic, and the bottom part is steep –more inelastic. The point where these two parts meet is P*. It is assumed that above this price any price hike is not followed by rivals, but if the firm reduces price below P* rivals also reduce prices. So if a price is reduced below P*, then each firm expects its demand to rise. Since all firms follow this price reduction the real demand increase is lesser than expected for each firm. The demand curve is steeper for prices below P* and flatter for prices above P*.
NO, this model does not rule out competition. There is a reasonable degree of competition and firms are free to charge any price they deem co
ect/optimal. Competition still exists in terms of non price competition....