CBSE & NCERT Class 12 Economics Questions Answer Chapter 4 : Part-II
Hello students, below is a topic of Economics Questions Answer for Class 12 and Class 11 based on the pattern of CBSE Class 12 Economics. Use the following Economics Questions Answer to frame your answers and score extraordinary marks in your examinations.
You can visit the Economics Questions Answer for Chapter 4 Part – I
Question 1: What is the relation between market price and marginal revenue of a price-taking company?
Marginal revenue is defined as the change in the total revenue that occurs due to the sale of one more unit of output. It is calculated as
MRn = TRn − TRn − 1
MRn = Marginal revenue due to the nth unit of output
TRn = Total revenue due to n units of output
TRn − 1 = Total revenue due to (n − 1) units of output
Suppose that the market price is P
MRn = TRn − TRn − 1
= PQn − P (Qn − 1)
MR = PQn − PQn+ P
MR = P
Thus, for a perfectly competitive company, marginal revenue is equal to the market price per unit of output.
Question2: What conditions must hold if a profit-maximizing company produces positive output in a competitive market?
The following three conditions must hold if a profit-maximizing company produces a positive level of output (say equilibrium output Q*) in a competitive market:
1) MR must be equal to MC at Q*.
2) MC should be upward sloping or rising at Q*.
3) In short-run − Price must be greater than or equal to AVC. i.e. P ≥ AVC at Q*.
In the long run − Price must be greater than or equal to LAC.
Question 3: Can there be a positive level of output that a profit-maximizing company produces in a competitive market at which market price is not equal to the marginal cost? Give an explanation.
No, there cannot be any positive level of output that a company produces at which price is not equal to MC. Let us evaluate the following two cases where the price is not equal to MC
Case A: If P > MC
At output Oq1, Price is Kq1, while the MC is Lq1. So, Oq1 is not the profit-maximizing output. This is due to the fact that the company can increase its profit level by expanding its output to Oq2.
Case B: If P < MC
At output Oq3, the price is Hq3 and MC is Gq3. So, Oq3 is not the profit-maximizing output. This is because the company can increase its profit by reducing its output level to Oq2.
Thus, at a profit-maximizing point, the price must be equal to MC and it cannot be greater or lesser than MC.
Question 4: Will a profit-maximizing company in a competitive market produce a positive level of output in the short run if the market price is less than the minimum of AVC?
No, it is not possible for a company to produce a positive level of output in the short run if the price is less than the minimum of AVC. This is because as soon as the market price falls below the minimum of SAVC, it implies that the company is not able to cover it’s fixed as well as variable costs, and thus it will stop the production.
Let us understand this concept by taking an example:
At point K, the price charged by the company is ON and the output sold is Oq1, and the company generates TR.
TR = P × Q
= OP × Oq1
= area (rectangle Oq1LP)
And incurs the variable cost of TVC
TVC = SAVC × quantity of output
= ON × Oq1
= area (rectangle Oq1KN)
Profit earned by the company = TR − TC = TR − (TVC + TFC)
= TR − TVC − TFC
If the company is not producing anything then at zero levels of output, the company’s TR and TVC will be zero. However, the company has to bear TFC. Thus at zero levels of output, the profit earned by the company is
Profit = π1 = TR − TVC − TFC
π1 = −TFC
Now if it produces Oq1 level of output, then the profit earned will be
π2 = TR − TVC − TFC
= area (rectangle Oq1LP) − area (rectangle Oq1KN) − TFC
Or, π2 = −area (rectangle PLKN) − TFC
This implies that π1 is greater than π2. The company incurs more loss if it produces an Oq1 level of output than the loss associated with zero levels of output. Thus the company will stop production whenever P < SAVC and therefore at profit-maximizing level of output, the price must be greater than or equal to SAVC in the short run.
Question 5: Will a profit-maximizing company in a competitive market produce a positive level of output in the long run if the market price is less than the minimum of AC? Give an explanation.
No, it is not possible for a company to produce a positive level of output in the long run if the market price falls short of the minimum of AC. This is because, in the long run, there is free entry and exit of companies and all companies earn a normal profit. Therefore, any company making losses, in the long run, will stop production.
Let us understand this concept through an example:
At Oq1 level of output,
Price charged by the company = OP.
Revenue generated by the company (TR) = P × Q
= OP × Oq1
= area (rectangle Oq1LP)
Cost of producing Oq1 level of output (TC) = LAC × quantity of output
= ON × Oq1
TC = area (rectangle Oq1KN)
Profit earned by the company = TR − TC
= area (rectangle Oq1LP) − area (rectangle Oq1KN)
= − area (rectangle NKLP)
Thus, the loss incurred by the company is equal to the area of the rectangle NKLP.
In the long run, all companies earn zero economic profit, and if any company earns a loss or negative profit, then the company will shut down its production. Thus, if the company earns loss, i.e. if the price is lesser than LAC at any level of output, it will not be the profit-maximizing output level of the company.
Question 6: What is the supply curve of a company in the short run?
The short-run supply curve of a perfect competitive company is the summation of the upward sloping portion of SMC (above the minimum point of SAVC), when price ≥ min SAVC, and the vertical portion of price-axis when price < min SAVC.
When the price is greater than or equal to a minimum of SAVC, i.e., P ≥ min SAVC.
At the market price OP, the three following conditions for equilibrium are fulfilled:
- MC = MR
- MC is upward sloping
- Price exceeds the minimum of SAVC
At this market price, the company is producing profit-maximizing output Oq1.
In this case, the supply curve of the company is regarded as the upward sloping part of SMC (above the minimum point of SAVC), i.e. SS. When the price is greater than or equal to a minimum of SAVC, the supply curve is indicated by SS.
When the price is less than the minimum of SAVC
Let us suppose that the company is facing a price OP1 that is less than the minimum of SAVC. At this price, the company cannot continue production as it cannot even cover up its variable costs and thereby incurs losses, which implies that the company would produce nothing. Thus, it will incur loss that will be equivalent to its fixed costs. It will be lesser as compared to the losses associated with producing any positive output level. Thus, the company will not produce anything at this price and thereby the quantity supplied will be zero. The company’s supply curve is indicated by the darkened vertical lines, S1S1.
Therefore, the short-run supply curve of a perfectly competitive company is (SS + S1S1).
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