SPECIAL ASSIGNMENT OF CRITICAL THINKING ESSAYS

(SACE)

MERGED MID TERM AND END TERM EXAMINATION

SEMESTER 1

HIDAYATULLAH NATIONAL LAW UNIVERSITY,

RAIPUR, CHHATTISGARH

SUBJECT
PRINCIPLES OF ECONOMICS

Submitted By
Name: J Sai Jaanvi
Semester: 1st semester
Roll no: 184
ID: 21/2021/2594
 SACE I

PRINCIPLES OF ECONOMICS

Answer 1.
Given Information:
There is an aluminium smelting plant which has two lines and each produces approx
300-400 tons of aluminium. The plant cannot be sold.We must ignore the fixed costs
and focus only on the variable costs. In usual cases the plant works on 2 shifts and
produces 600 tons of aluminium. On high price days the plant works for 3 shifts and
produces more than 600 tons, where the wages, maintenance costs and the freight
charges double.

Total Variable cost:

The total variable cost of a company's production is the sum of all the costs associated
with producing a single unit of product. This figure is calculated by multiplying the
cost of producing one unit by the total number of units produced.

Total Output Quantity x Variable Cost Of Each Output Unit = Total Variable Cost.

Average Variable Cost:

The average variable cost is a distinct formula that tells you how much it costs to
make a single unit of goods on average. When determining variable costs per product
for items with varied unit costs, the average variable cost is applied.

Average Variable Cost = Total Variable Cost / Output

Average Total Cost

The average total cost is the cost per unit multiplied by the number of units produced.
Both fixed and variable expenses are included in the average total costs.
(Total Fixed Costs + Total Variable Costs) / Number Of Units Produced = Average
Total Cost

Marginal Cost:
The extra cost incurred in the manufacture of additional units of products or services,
most commonly utilised in manufacturing, is known as marginal cost. It's derived by
dividing the change in expenses by the change in quantity, and it includes both fixed
and variable costs for things that have already been created.

Marginal Cost = Change In Costs / Change In Quantity1

Question 1
S.NO Output TFC TVC TC AC AVC MC
(tons)
1 1 0 1,465 1,465 1,465 1,465 0
2 2 0 2,930 2,930 1,465 1,465 1,465
3 3 0 4,395 4,395 1,465 1,465 1,465
4 - - - - - - -
5 598 0 8,76,070 8,76,070 1,465 1,465 1,465
6 599 0 8,77,535 8,77,535 1,465 1,465 1,465
7 600 0 8,79,000 8,79,000 1,465 1,465 1,465
8 601 0 8,80,785 8,80,785 1465.53 1465.53 1,785
9 602 0 8,82,570 8,82,570 1466.06 1466.06 1,785

Question 2
Costs reduce in the long run when output rises owing to economies of scale, lowering
the average cost AC of production. When the average cost rises, certain businesses
encounter diseconomies of scale. In the long term, this fall and rise results in a U-
shaped or boat-shaped average cost curve, abbreviated as LAC. In the long term, the

1
Mankiw, Gregory. “Principles of Economics.” Principles of Economics, 8 ed., Cenage Learning, 2016,
https://voltariano.files.wordpress.com/2020/03/mankiw_principles_of_economic.pdf.
minimal point on the curve is said to represent the optimal output. The chart below
illustrates this point graphically.

All components are changeable in the long run, and the average cost may decrease or
rise to A, B, but all of these costs are higher than the long run cost average cost.
Because it contains all of the short run average cost curves, LAC is the bottom
envelope. When the SAC1 and SMC1 meet at position 'E,' the organisation must
spend the OC1 amount if it wants to boost its output from OM to OM1. If the
company buys another machine (an increase in fixed costs), they'll obtain a new pair
of cost curves, SAC2 and SMC2. However, the revised average cost curve lowers the
production cost from OC1 to OC2. That means they can save the difference between
C1 and C2, which is AB.2
At low production levels, the long-run average cost curve often declines because there
are cost or production efficiencies that may be leveraged for moderate increases in
quantity. For example, if a company manufactures major appliances or vehicles that
require multiple assembly steps, it is possible to assign different assembly steps to
different workers in a larger operation and, as a result of this specialisation, increase
the rate of production over what would be possible if the company hired the same
workers to perform all assembly steps. Customers that buy in big numbers might often
get a reduced per unit pricing, as we mentioned in the previous chapter. Because most

2
“Cost Output Relationship In The Long Run - Cost Analysis.” BrainKart,
http://arts.brainkart.com/article/cost-output-relationship-in-the-long-run---cost-analysis-664/ . Accessed
6 12 2021.
businesses are both buyers and sellers, and larger businesses will buy in larger
quantities, the proportion of acquired components and materials to the average cost
can be reduced.3

SACE II

Answer 1.

Equilibrium of a firm4
The term "equilibrium" comes from science. It's a condition of no changes in which
opposing forces balance out. When a customer achieves maximum happiness from his
earnings, he is in equilibrium.
Equilibrium also refers to a condition in which there is no trend for new enterprises to
enter or quit a certain industry. When a company is pleased with its current level of
output, it is said to be in equilibrium. In this case, the business will create the amount
of output that yields the most profit or the least loss. The firm is now in balance when
it reaches this point.
Conditions for attaining equilibrium
When a company meets the following criteria, it is considered to be in equilibrium:
1. The first criterion for the firm's equilibrium is that its profit be maximised.
2. Marginal revenue and marginal cost should be equal.
3. MC must cut MR from below.
Total Revenue and Total Cost Approach:
When a company optimises its profit, it is considered to be in equilibrium. It reaches
this position when it shows no signs of increasing or decreasing production. Profits
are now calculated as the difference between total revenue and total expense. To
achieve equilibrium, the company will try to maximise the gap between total revenue

3
4.2 Long-Run Average Cost and Scale, https://saylordotorg.github.io/text_principles-of-managerial-
economics/s04-02-long-run-average-cost-and-scal.html . Accessed 7 December 2021.
4
Kumar, Manoj. “Equilibrium Of Firm And Industry: Definitions, Conditions And Difficulties.”
Economics Discussion, Www.economicsdiscussion.net, 8 May. 2015,
https://www.economicsdiscussion.net/firm/equilibrium-of-firm-and-industry-definitions-conditions-
and-difficulties/7225.
and total costs. The vertical distance between total cost and total revenue is greatest
when the vertical distance between total cost and total revenue is greatest.

Figure 1 shows output on the X-axis and price/cost on the Y-axis. The total revenue
curve is abbreviated as TR. It is a 45° straight line that bisects the origin. It denotes
that the commodity's price is fixed. Only perfect competitiveness may produce such a
situation.

The total cost curve is abbreviated as TC. The total profit curve is abbreviated as TPC.
TC curve is above TR curve up to OM1 output level. It's the danger zone. The
business only covers costs TR=TC at OM1 output. Point B denotes a profit of nothing.
The break-even point is what it's termed. The difference between TR and TC is
positive beyond OM1 output and up to OM2 output. Because the vertical difference
between the TR and TC curves (PN) is greatest at OM output, the corporation makes
the most profit.
The tangent on the TC curve at point N is parallel to the TR curve. The dotted curve
depicts the behaviour of total profits. At OM production, total earnings are at their
highest. TC is identical to TR at the OM2 output. Profits plummet to nil. At OM]
output, losses are minimal. The company has entered the profit zone after crossing the
loss zone. The break-even point-B denotes this.

Short run equilibrium of a firm

Short-run refers to the time period during which fixed elements stay unaltered and
enterprises can modify their production by altering variable components such as
labour, raw materials, and so on in order to maximise profits. It is not required for
enterprises to achieve super-normal or regular profits in the near term, and they may
even have to incur losses.

Because businesses cannot enter the sector in the short run, a firm may make
abnormal profits. Furthermore, a company may lose money if it does not increase
output in the short term, even if the product's price reduces. If it briefly halts
production, it will be responsible for the loss of fixed costs, which will be the firm's
minimal losses.
A firm’s plan to attain equilibrium
 When a firm's marginal cost equals its marginal revenue and the marginal cost
curve cuts the marginal revenue curve from below, it is said to be in equilibrium.
If average revenue exceeds marginal cost, a company in equilibrium makes
super-normal profits.
 The term "normal profits" refers to earnings in which the firm's average cost
equals its average revenue. These gains are used to pay the cost of manufacturing
and only cover the incentive for entrepreneurial services. A figure can be used to
demonstrate it.
 When a business in equilibrium does not cover the average cost, it suffers losses.
To put it another way, when average revenue falls short of average cost, the
company must lose money.
Why MSMEs continue to run in losses
The simple question is why companies continue to produce a product if they are
losing money. Firms cannot exit the industry in the short term by disposing of the
plant. Why don't they just turn off? It's because they can't modify the fixed variables,
and even if the company closes, they'll have to pay fixed expenses.
Only variable expenses may be avoided, while fixed costs must be paid whether the
company produces or not. The company will continue to produce until the average
variable cost is covered by the price. The producer will continue to produce if the
price covers some of the average fixed costs in addition to the variable expenses. As a
result, the company will continue to produce as long as the price exceeds the average
variable cost. A diagram can be used to demonstrate the shut down point.\
Equilibrium is at E in the figure above, when MR = MC and MC cuts MR from below.
The production is OQ, while the price is EQ. The average variable cost is covered by
this price. The average cost associated with this product is AQ. As a result, the loss
per unit is equal to AE, which is the average fixed cost. Total fixed expenses are
equivalent to total losses. The company will not produce at all if the price is
significantly below the OP level. The company will simply halt manufacturing and
wait for better times to arrive.
Shut Down Point (Losses=Total Fixed Costs)
However, the company may be able to continue operating despite the condition for the
following reasons:
1. The business may continue to function since an ongoing concern receives a greater
valuation (worth) than a closed down one.
2. The owner or manager of a continuing business has more prestige than the owner or
management of a company that has closed or discontinued operations.
3. The company will not lose skilled workers if the operation continues.
4. The company may continue to exist in the hopes of making money in the future.

If the perfectly competitive company is faced with a market price that is higher than
the shutdown threshold, the firm is at least paying its average variable costs. At a
price above the shutdown point, the firm is also making enough revenue to cover at
least a portion of fixed costs, so it should continue to operate even if it is losing
money in the short term, because the losses will be smaller than if it shuts down
immediately and loses all of its fixed costs. If, on the other hand, the business receives
a price that is lower than the price at the shutdown point, the firm will not be able to
pay its variable expenses. Staying open in this scenario is increasing the firm's losses,
and it should close down immediately.
 price < minimum average variable cost, then firm shuts down
 price > minimum average variable cost, then firm stays in business5

Conclusion

Firms with fixed expenses that cannot be removed in the short or medium term would
continue to manufacture and sell their products even if they are losing money in
economic theory (and rationally), because stopping production and selling would
result in much higher losses.

Whether or not the company decides to stop producing and selling is determined by
its ability to make a positive contribution margin. The company can generate a
positive contribution margin to assist minimise its overall losses as long as its selling
price for its products is larger than its variable expenses. Variable costs are expenses
incurred only when a company produces its goods.

5
“The Shutdown Point | Microeconomics.” The Shutdown Point | Microeconomics,
Courses.lumenlearning.com, https://courses.lumenlearning.com/wmopen-microeconomics/chapter/the-
shutdown-point/.