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Q.1 How do specialization economies and diminishing marginal returns affect the shape of the firm's short-run marginal cost curve? Provide a complete explanation in support of your answer.
Ans. Short run implies that the firm employs two types of factors of production, i.e fixed and variable. As the name explains that fixed factors of production cannot be altered in the short run and the production can be adjusted while adjusting the variable factors of production.
Marginal cost refers to the change in the total cost of production when a firm increases production by 1 unit. Marginal cost curve represents the relationship between the incremental cost of production and quantity produced.
The marginal cost curve is a U shaped curve, depicting that the incremental cost of production falls in the initial stages of production, remains constant for the next few production units and finally increases.
The U shape of the Marginal cost curve is because of the factors of production and marginal returns play an important role in cost determination. In the initial stages, division of labor and economies of scale and specialization sets in; thereby leading to the incremental fall in the cost. As and when firm continue to exploit fixed factors of production by employing more and more of variable factors, the incremental cost of production increases thereby leading to a typical U shaped Marginal cost curve.
Q.2 Show graphically and explain how a price floor leads to changes in consumer surplus, producer surplus and total welfare in the market?
Ans. Price floor can be defined as the minimum price fixed by the regulatory authority at which the goods can be traded. The price floor is generally higher than the equilibrium price and interferes with the market mechanism of price and quantity determination.
Consumer or buyer surplus refers to the difference of the value placed by the consumer for a good and the actual price is borne by the consumer while purchasing the product. The case where the value of goods placed by the consumer is more than the actual price paid; consumer surplus is positive. Consumer or Buyer Surplus is graphically represented by the area below the...