Importance of Costs in Economics

Answers to the questions
1) Costs are important in economic as they reflect the market prices of resources that are
utilized in the production process. Additionally, the economic costs are also inclusive
of the opportunity cost resources that may not have an explicit market price by are
used in the enterprise.
2) Economists regard that all the resources are paid, including the business owner, to
continue the business. Further, the natural resources, entrepreneurship, capital, and
labor are compensated. This means that the normal profits comprise of the implicit
costs of the lost opportunities and doing the business. Hence, the earnings that are
more than the normal profits, are considered as the economic profits, otherwise it is
considered the economic loss.
3) The statement that “If the economic profit is zero, a business will shut down,” is
incorrect. The economic profits being zero, is an indicator that the business has
covered all the associated explicit and implicit costs, which includes the normal profit
as well. Therefore it can be stated that there is no incentive to wind up the present
business and start a new venture in a new industry.
4) In the long run production function, the producers have the flexibility over all the
relevant production decisions. In contrast to this, in the short run production function,
the scale of an operation is fixed and the only business decision that can vary is the
number of workers to employ. Thus, the main difference is the absence of the fixed
factors in the long run and the existence of the both fixed and variable factors in the
short run.
5) Long run in economics is a period of time in which all factors of production and costs
are variable, thereby allowing the firms to be able adjust all costs. The long run as a
responsive measure post the short run shocks.
6) The total product refers to the maximum output that can be produced from a given
amount of a fixed input. The Average Product is the Total Product divided by the total
amount of the variable input used in the production. The Marginal Product denotes the
increase in the total output by increasing one unit in the amount of the variable input.
7) As per the law of the diminishing returns, if more of the variable inputs are employed
without the change in the fixed input, then the marginal product will decline leading
to the decline in the total product and the average products as well.
8) As per the law of diminishing returns, if one or more variable factors of production
are added to a fixed factor of production, this will lead to the increase in the output,
but the increase would eventually be at a decreasing rate. Thus, the food production
can be increased by employing more seeds, fertilizers and other inputs, but after a
point there will be diminishing increments in the output of food.

9) It must be noted that there is an assumption of equality in all units of variable inputs
as per the law of diminishing returns. Thus, in the given scenario workers possess
equal quality or are homogeneous. The decrease in the marginal product is therefore
not owning to the quality of the workers, but because there are more number of
workers as against the relative capacity of fixed plant and equipment.
10) As per the law of diminishing returns, after a point of time adding an additional factor
of production would lead to smaller increases in output. For instance, an individual
plans to read 30 pages in an hour, he will be able to read 30 pages in 1st hour,
followed by 40 pages in 2nd hour and so on. However, with each passing hour after the
maximum capacity is reached, the efficiency to understand the text will reduce.
11)
Labour Total
Product
MP TVC TFC TC MC
0 0 0 0 100 100
1 20 20 200 100 300 10
2 55 35 400 100 500 5.71
3 100 45 600 100 700 4.41
4 150 50 800 100 900 4.00
5 200 50 1000 100 1100 4.00
6 230 30 1200 100 1300 6.66
7 250 20 1400 100 1500 10.00
8 263 13 1600 100 1700 15.38
9 270 7 1800 100 1900 28.57
10 275 5 2000 100 2100 40.00
11 278 3 2200 100 2300 66.66
12 280 2 2400 100 2500 100
With the increase in the marginal product from 0 to 50, there is a fall in the marginal
cost from $10 to $4. This is followed by simultaneous increases in marginal cost from
$4 to $100 and the fall in the marginal product from 50 to 2. When the output reaches
beyond 200, the law of diminishing returns set in.
12) There is an inverse relationship between the marginal costs and the marginal product.
With the increase in the marginal product, there is a proportional decline in the
marginal cost and vice versa.
13) There is a rise in the short run marginal cost curve in the typical firm due to the rise in
costs pertaining to the increasing inefficiency in the production. As the size of the
firm is fixed, there is a limit on the production, however variable cost increase leading
to marginal costs increments.