1. Refer to Table and Graph in Appendix. 2.

Diminishing returns refer to a situation when the resulting output does not justify the cost of the resources utilised. It means that the resources utilised in a particular area no longer return enough rewards. The idea states that other factors remaining the same, when an equal amount/quantity of one factor is increased; a point arises where the work involved to perform a task ceases to be as profitable. Looking at the table, we can see that as the quantity produced goes beyond five units, the marginal cost begins to rise. It can be seen that the marginal cost is constantly decreasing as we increase the quantity produced from 0 to 4 units. However, as the quantity produced increases to 5 units, the marginal cost is same as it was for producing 4 units i.e. $6 per unit. As we produce more units, the marginal cost increases from $6 per unit to $26 per unit for producing 9 units. This is due to the fact that when factors of production remains the same, as more and more investment/effort is put in, the resulting output begins to decline because after a certain stage factors begin to exhaust. 3. Average Total Cost (ATC) is the sum of Average Variable Cost (AVC) and Average Fixed Cost (AFC). As the output increases, AFC tends to decline since the cost can be spread over an increasing number of units, whereas the AVC is directly related to the number of units so it increases with an increase in the output. ATC is the sum of AVC and AFC so it reflects the shape of both these curves. At a low level of output, ATC is generally high because the AFC is spread over less number of units. However, it tends to decline as the output increases. However, as we can see from the table, ATC is continuously declining and till firm produces 7 units, where the ATC is at its lowest ($20). As the output increases to 8 units and above, ATC begins to rise again due to increasing AVC. This gives us a U-shaped ATC curve as it begins to rise again after reaching its minimum. 4. The efficient scale of a firm is the point that minimises the Average Total Cost of the firm. Since the ATC curve is U-shaped, efficient scale is the bottom of the curve. In this case, ATC of ABC Company is lowest ($20) when it produces 7 units. As firm produces more, its ATC begins to go up. Hence the efficient scale of ABC occurs at 7 units of output. 5. Profit maximisation is a phenomenon that can be determined on the basis of the marginal revenue and the marginal cost. In order to determine ABC Companys profit maximising output, we compare the marginal cost and the marginal revenue calculated in the table. As we can see from the table, marginal cost is initially higher than the marginal revenue. At 1 unit of

output, the MC of the company is $30 where as the MR is $24. As a result, the company has a loss of $6. As the company produces one more unit of output, the loss reduces to $4. As company produces 3 units of output, the MC goes down to $8 whereas the MR is $24, which means the company has a profit situation when it produces 3 units of output. In order to reach the profit maximisation point, the company would carry on producing till the point where MR=MC. As we see from the table, when the company produces 8 units of output, the MR is $24, which is equal to the MC. If the company produces another unit, MC ($26) is again greater than MR ($24). Hence, the profit maximisation point is 8 units of output where MR=MC=$24. 6. Refer to graph in Appendix. 7. The ATC curve in the long run differs from the ATC curve in the short run as the fixed costs become variable in the long run. As a result, the company can benefit from greater flexibility in the long run. The firm can afford to increase its production and spread the fixed cost over a greater number of units in the long run whereas in the short run, the firm has no option but to hire more labour in order to expand the production. As a result, ATC of the firm is expected to go down in the long run and may be able to sustain at a market price of $24 but in the short run, it may not be able to sustain due to higher fixed cost and variable cost. As can be seen from the table, profit of the company begins to decline from $28 to $26 as company approaches 9 units of output. As a result, the profit may disappear if the company produces another 2-3 more units. However, in the long run, as the fixed cost starts to become variable and can be spread over a greater number of units, the firm may be able to make profit even by selling at a price of $24 per unit. 8. As ABC Company prevails in a highly competitive environment where there is no restriction on entry and exit of other firms in the industry, the long run price of the firm would be equal to its average total cost (ATC). The economic profit of ABC Company or any other firm in such competitive environment is driven to zero due to free entry and exit. In the long run when the firms are making losses, other firms in the market see an incentive in an exit from the industry. This gives customers fewer products to choose from resulting in expansion of demand for those who stay in the market. As the demand increases, the firms in the industry experience rising profit. This process continues until the firms in the industry are making exactly zero economic profit. As a result, it is difficult to determine if the industry would experience an increase or decrease in the number of firms because on one side, rising

profits would attract the firms to enter the industry, while on the other side decline in demand would result in firms making losses and choosing to exit the industry. 9. As the fixed cost of the company goes down to $20, the ATC of the company goes down as well. However, this does not result in any change in the efficient scale of the company. Though the ATC goes down, it still remains lowest at 7 units of output ($16.28), whereas earlier it was $20. As the ATC of the company goes down, the company would be making higher profit in the short run. As can be seen from the table, the company starts making profit at 4 units of output ($12), as compared to a profit of $4 by producing 5 units of output when the fixed cost was $46. However, in the long run, due to free entry and exit, the rising profit would attract newer firms resulting in the economic profit going down to zero. The long run equilibrium price of the firm would be the ATC of the firm i.e. the price at which it would not be making any exorbitant profits. 10. As the variable cost of the company goes down by $4 at each unit of output, it affects the Total cost of the company. As a result, the total cost goes down by $4 every time an extra unit of output is produced. This increases the profit of the company by $4 at each unit in the short run. However, in the long run it may have a bigger impact on the profit as the fixed cost would tend to become variable as more and more units are produced. The company would be able to reduce the total cost of production which may allow the company to generate higher profit at a low price level as well. This may also allow the company to operate at the market price of $24 in the long run. The long run equilibrium price of the firm depends on the ATC of the firm, which goes down as the variable cost goes down by $4 at each extra unit of output produced. As a result, the long run equilibrium would be achieved at a price level lower than the current market price i.e. $24.