This document contains an assignment for MBA students at Rift Valley University in Harar, Ethiopia. The assignment covers various topics in managerial economics, including the effects of managerial decisions on firm value, areas of decision making, demand estimation and forecasting, elasticity of demand, production functions, costs, and market structures. Students are asked to analyze case studies, define key concepts, derive equations, and discuss topics like marginal cost, opportunity cost, economies and diseconomies of scale. The assignment involves quantitative and qualitative questions and requires applying economic principles to managerial decision making.

1. Rift Valley University
Harar Campus
Department of Masters of Business
Administration
Group Assignment of Managerial
Economics
Instructor: - Dr. Temesgen Kebede
By:-
1. Iliyas Sufiyan Abdella
2. Abduqadir Ahmed Mume
3. Seada Abdulaziz Ali
4. Aisha Zeki Esmail
5. Misra Mohammed Adem
6. Salim Ahmed Sali
7. Ikram Abdi Yuyo
8. Abdukadir Adem Deko
9. Ahmed Mume Baker
10. Timaj Kore Abdi

2. Rift Valley University
Harar Campus
Managerial economics assignment for MBA students
1. Managerial economics is an application of the principles of economics in
managerial decision making. The economic way of thinking about
business decision making provides all managers with a powerful set of
tools and insights for furthering the goals of their organization. Describe
the effects of each of the following managerial decisions or economic
influences on the value of the firm:
A. The firm is required to install new equipment to reduce air
pollution.
B. Through heavy expenditures on advertising, the firm’s marketing
department increases sales substantially.
C. The production department purchases new equipment that lowers
manufacturing costs.
D. The firm raises prices. Quantity demanded in the short run is
unaffected, but in the longer run, unit sales are expected to decline.
E. The National Bank of Ethiopia takes actions that lower interest rates
dramatically.
F. An expected increase in inflation causes generally higher interest
rates, and, hence, the discount rate increases.
2. Identify the areas of decision making where managerial economics
prescribes specific solutions to business problems
3. Discuss the role of Demand Estimation and Demand Forecasting in the
success of a Business Firm
4. Estimate the sales for 2022, 2023, 2024 and fit a linear regression
equation and draw a trend line.
Year 2014 2015 2016 2017 2018 2019 2020 2021
Sales
22734 24731 31489 44690 51320 55330 65890
75800
5. Discuss the cross elasticity of demand with an example. List out the
significance of elasticity of demand in managerial decision making.
6. Explain the consumer survey method and discuss the merits and
demerits of complete enumeration method and sample survey method.

3. 7. The demand for petrol rises from 500 to 600 Barrels when the price of a
particular scooter is reduced from ETB 25,000 to ETB 22,000. Find out
the cross elasticity of demand for the two. What is the nature of their
relationship?
8. Define production function and Cobb-Douglas production function
9. What do you mean by an expansion path?
10. Describe the following
A. What is Marginal cost? State its significance in cost analysis.
B. Define opportunity cost and give an example.
C. Explain the concepts: AFC, AVC, ATC and MC.
D. Explain briefly the various types of costs with suitable examples.
E. Discuss the short run cost output relationship with the graph.
F. Derive long run total cost curve.
G. What is the relationship between AC and MC?
H. Give reasons for the U shape of long run AC curve.
I. Distinguish between economies of scale and diseconomies of scale with
a graph.
J. List out the factors that cause economies and diseconomies of scale.
11. Mention the characteristics of monopoly, oligopoly, and monopolistic
competitive and perfect competitive market structure and make
comparison.
12. There are four ways to manage the risk and uncertainty:
 Insurance (Business risks are transferred through Insurance
Policies)
 Hedging is a mechanism whereby the expected loss is to be offset by
an expected profit from another contract.
 Diversification is a method of managing the risk where the risk is
spread to various investments and thus the risk is minimized to
each investment.
 Adjusting risk is the mechanism whereby the provision is made to
offset the expected loss.
Decision under Uncertainty:
 The maxima rule: Deals with selecting the best possible outcome
for each decision and choosing the decision with the maximum
payoff for all the best outcomes.
 The Maximin rule: Deals with selecting a worst outcome for each
investment decision and choosing the decision with the maximum
worst payoff.

4.  The Minimax rule: Deals with determining the worst potential
regret associated with each, decision, then choosing the decision
with the minimum worst potential regret.
Based on the information provided above, assume you are the manager
of a given company that own land that might contain oil. Assume more
that the land has a value of $5 million. If the land is drilled and find out
oil, you can have a value of $40 million. You will incur a cost of drilling
for oil is $12 million. If you find no oil; you will have a value of $3million.
 Value of land – $5 million
 Drill for oil – $12 million
 Find oil – $40 million
 Find no oil – $3 million
What will be your decision? Will you sell or drill the land?
Required:
 Prepare pay off table
 Make a decision based on:
 Expected value/probability distribution given the probability
of getting oil is 60%/
 Maxima approach/best case scenario/
 Maximum approach /best worst case scenario/
 Minima regret approach/opp. cost approach/

5. ANSWER (1)
A. The most direct effect of a requirement to install new pollution control
equipment would be an increase in the operating cost component of the
valuation model. Secondary effects might be expected in the discount
rate due to an increase in regulatory risk, and in the revenue function if
consumers react positively to the installation of the pollution control
equipment in production facilities.
B. All three major components of the valuation model--the revenue function,
cost function, and the discount rate--are likely to be affected by an
increase in advertising. Revenues and cost will both increase as output is
expanded. The discount rate may be affected if the firm's profit outlook
changes significantly because of increased demand (growth) or if
borrowing is necessary to fund a rapid expansion of plant and equipment
to meet increased demand.
C. The primary effect of newer and more efficient production equipment is a
reduction in the total cost component of the valuation model. Secondary
effects on firm revenues could also be important if lower costs make price
reductions possible and result in an increase in the quantity demanded
of the firm's products. Likewise, the capitalization rate or discount factor
can be affected by the firm's changing prospects.
D. The time pattern of revenues is affected by such a pricing decision to
raise prices in the near term. This will alter production relationships and
investment plans, and affect the valuation model through the cost
component and capitalization factor.
E. A general lowering of interest rates leads to a reduction in the cost of
capital or discount rate in the valuation model.
F. Higher rates of inflation, leading to an increase in the discount rate,
cause the present value of a constant income stream to decline. Unless
the firm is able to increase product prices in order to maintain profit
margins, the value of the firm falls as inflation and the discount rate
increases. Of course, the economic effects of inflation on the economic
value of the firm are complex, involving both asset and liability
valuations, so determining the overall effect of inflation on the economic
value of individual firms is a difficult task.

6. Answer (2)
Decision-making is crucial for running a business enterprise which faces a
large number of problems requiring decisions. Which product to be produced,
what price to be charged, what quantity of the product to be produced, what
and how much advertisement expenditure to be made to promote the sales,
how much investment expenditure to be incurred are some of the problems
which require decisions to be made by managers.
The five steps involved in the managerial decision-making process are
explained below:
 Establishing the Objective.
 Defining the Problem.
 Identifying Possible Alternative Solutions (i.e. Alternative Courses of
Action)
 Evaluating Alternative Courses of Action
 Implementing the Decision
Explanation:
i. Establishing the Objective:
The first step in the decision-making process is to establish the objective
of the business enterprise. The important objective of a private business
enterprise is to maximize profits. However, a business firm may have
some other objectives such as maximization of sales or growth of the
firm.
ii. Defining the Problem:
The second step in the decision-making process is one of defining or
identifying the problem. Defining the nature of the problem is important
because decision-making is after all meant for the solution of the
problem.
Identifying Possible Alternative Solutions (i.e. Alternative Courses of
Action): Once the problem has been identified, the next step is to find
out alternative solutions to the problem. This will require considering the
variables that have an impact on the problem. In this way, a relationship
among the variables and with the problems has to be established.

7. iii. Evaluating Alternative Courses of Action:
The next step in business decision-making is to evaluate the alternative
courses of action. This requires the collection and analysis of the relevant
data. Some data will be available within the various departments of the
firm itself, the other may be obtained from the industry and government.
iv. Implementing the Decision:
After the alternative courses of action have been evaluated and the
optimal course of action selected, the final step is to implement the
decision. The implementation of the decision requires constant
monitoring so that expected results from the optimal course of action are
obtained. Thus, if it is found that expected results are not forthcoming
due to the wrong implementation of the decision, then corrective
measures should be taken.
Answer (3)
Demand forecasting is the process of using predictive analysis of historical data
to estimate and predict customers' future demand for a product or service.
Demand forecasting helps the business make better-informed supply decisions
that estimate the total sales and revenue for a future period of time.
For enterprises, demand forecasting allows for estimating how many goods or
services will sell and how much inventory needs to be ordered. Demand
forecasting lays the foundation for many other critical business assumptions
such as turnover, profit margins, cash flow, capital expenditure, and capacity
planning.
Demand forecasting helps reduce risks and make efficient financial decisions
that impact profit margins, cash flow, allocation of resources, opportunities for
expansion, inventory accounting, operating costs, staffing, and overall spend.
All strategic and operational plans are formulated around forecasting demand.
Demand estimation is any means to model how consumer behavior changes
due to changes in the price of the product, consumer income, or any other
variable that impacts demand. ... Demand estimation provides information
about the prices and respective quantities that consumers are willing to
demand.
Disadvantages of forecasting
 Forecasts are never 100% accurate
 It can be time-consuming and resource-intensive
 It can also be costly

8. Answer (4)
Year X Sales (Y) XY x 2
2014 1 22734 22734 1
2015 2 24731 49462 4
2016 3 31489 94467 9
2017 4 44690 178760 16
2018 5 51320 256600 25
2019 6 55330 331980 36
2020 7 65890 461230 49
2021 8 75800 606400 64
∑X = 36 ∑Y = 371984 ∑XY = 2001633 ∑ x 2 = 204
∑Y = na + b∑X ---------------------------- (i)
∑XY = a∑X + b∑X2 ---------------------------- (ii)
371984 = 8a + 36b ------------------------------ (i)
2001633 = 36a + 204b --------------------------- (ii)
a =11386.75
b = 7802.5
Y = a + b X
Y = 11386.75 + 7802.5X
Sales for 2022 = 11386.75 + 7802.5(8) = 73806.75
Sales for 2023 = 11386.75 + 7802.5 (9) = 81609.25
Sales for 2024 = 11386.75 + 7802.5(10) = 89411.75
Answer (5)
The cross elasticity of demand is an economic concept that measures the
responsiveness in the quantity demanded of one good when the price for
another good changes. Also called cross-price elasticity of demand, this

9. measurement is calculated by taking the percentage change in the quantity
demanded of one good and dividing it by the percentage change in the price of
the other good.
A positive cross elasticity of demand means that the demand for good A will
increase as the price of good B goes up. This means that goods A and B are
good substitutes. So that if B gets more expensive, people are happy to switch
to A. An example would be the price of milk.
 The cross elasticity of demand is an economic concept that measures the
responsiveness in the quantity demanded of one good when the price for
another good changes.
 The cross elasticity of demand for substitute goods is always positive
because the demand for one good increases when the price for the
substitute good increases.
 Alternatively, the cross elasticity of demand for complementary goods is
negative.
Answer (6)
Consumer Survey Method is one of the techniques of demand forecasting that
involves direct interview of the potential consumers.
Consumer Survey Method includes the further three methods that can be used
to interview the consumer:
Complete Enumeration Method: Under this method, a forecaster contact
almost all the potential users of the product and ask them about their future
purchase plan. The probable demand for a product can be obtained by adding
all the quantities indicated by the consumers. Such as the majority of children
in city report the quantity of chocolate (Q) they are willing to purchase, then
total probable demand (Dp) for chocolate can be determined as:
Dp = Q1+Q2+Q3+Q4+……+Qn
Where, Q1, Q2, Q3 denote the demand indicated by children 1, 2,3 and
so on.

10. One of the major limitations of this method is that it can only be applied where
the consumers are concentrated in a certain region or locality. And if the
population is widely dispersed, then it can turn out to be very costly. Besides
this, the other limitation is that the consumers might not know their actual
demand in future. Due to this, they may give a hypothetical answer that may
be biased according to their own expectations regarding the market conditions.
Sample Survey: The sample survey method is often used when the target
population under study is large. Only the sample of potential consumers is
selected for the interview. A sample of consumers is selected through a
sampling method. Here, the method of survey may be a direct interview or
mailed questionnaires to the selected sample-consumers. The probable
demand, indicating the response of the consumers can be estimated by using
the following formula:
Where Dp = probable demand forecast; H = Census number of households from
the relevant market; Hs = number of households surveyed or sample
households; HR = Number of households reporting demand for a product; AD =
Average Expected consumption by the reporting households (total quantity
consumed by the reporting households/ Number of households.
This method is simple, less costly and even less time-consuming as compared
to the comprehensive survey methods. The sample Survey method is often
used to estimate a short-run demand of business firms, households,
government agencies who plan their future purchases. However, the major
limitation of this method is that a forecaster cannot attribute more reliability to
the forecast than warranted.
End-use Method: The end-use method is mainly used to forecast the demand
for inputs. This method of demand forecasting has a considerable theoretical
and practical value. Under this method, a forecaster builds the schedule of
probable aggregate future demand for inputs by consuming industries and
several other sectors. In this method, during the estimation of a demand the
changes in technological, structural and other factors that influence the
demand is taken into the consideration.

11. The end-use method helps in determining the future demand for an industrial
product in details by type and size. Also, with the help of end-use method, a
forecaster can pinpoint or trace at any time in the future as to where, why and
how the actual consumption has been deviated from the estimated demand.
Thus, these are some of the most commonly used consumer survey methods,
wherein the customers are directly asked about their intentions about the
product and their future purchase plans.
Answer (7)
The cross-price elasticity of demand is computed as:
Exy = % Change in the price of good Y
% Change in the demand for good X
Let petrol be good X and scooter be good Y.
If the demand for petrol increases from 500 to 600 barrels, then:
% Change in the demand for good X=
600 – 500  100 = 20%
500
If this increase in the demand for petrol is caused by a decrease in the
price of scooters from Birr. 25000 to Birr. 22000, then:
% Change in the price of good Y =
22000 – 25000  100 = -12%
25000
Therefore:
Exy = 20% = -1.67
-12%
The two goods are complements since the cross-price elasticity of
demand is negative.

12. Answer (8)
Production function, in economics, equation that expresses the relationship
between the quantities of productive factors (such as labor and capital) used
and the amount of product obtained.
The production function is the calculation by which the number of inputs
creates a number of outputs. In other words, it states the relationship between
inputs and outputs. So how much would x number of inputs be able to
produce. For example, a firm may have 5 workers producing 100 pins an hour.
If the firm hires another 5 employees alongside 100 pin supplies, then the
production function would suggest 100 pins would be produced.
There are four main factors of production – land, labor, capital, and
entrepreneurship. With regards to the production function, these factors would
usually be included in the inputs which create x number of outputs. The
number of which will depend on the production function which will vary from
product to product.
What is the Production Function?
The production function is the calculation by which the number of inputs
creates a number of outputs. In other words, it states the relationship between
inputs and outputs. So how much would x number of inputs be able to
produce. For example, a firm may have 5 workers producing 100 pins an hour.
If the firm hires another 5 employees alongside 100 pin supplies, then the
production function would suggest 100 pins would be produced.
There are four main factors of production – land, labour, capital, and
entrepreneurship. With regards to the production function, these factors would
usually be included in the inputs which create x number of outputs. The
number of which will depend on the production function which will vary from
product to product.
Key Points
The production function is a mathematical equation that calculates the
maximum output a firm can achieve with a selected number of inputs (capital,
labour, and land).
The production function can be calculated using the formula: Q = f(Capital,
Land, Labour), where the inputs are a function of the output.
The production function comes in two phases – the short-run and the long-run.

13. Some key concepts and measurements include:
Total Product: the total product of a firm refers to the number of goods that it
produces. In other words, it is simply the total output.
Average Product: the average product measures the output per worker or
output per unit of capital.
Marginal Product: the marginal product refers to the additional output
achieved by employing an additional unit of input. For instance, an additional
worker may be able to produce an extra 5 units. This is referred to in the short-
run.
A Cobb-Douglas production function models the relationship between
production output and production inputs (factors). It is used to calculate ratios
of inputs to one another for efficient production and to estimate technological
change in production methods.
The general form of a Cobb-Douglas production function for a set of n inputs is
Y=f(x1,x2,...,xn)=γ∏i=1nxαii
where Y stands for output, xi for input i, and γ and αi are parameters
determining the overall efficiency of production and the responsiveness of
output to changes in the input quantities. The application of this functional
form in measuring production is due to the mathematician Charles Cobb and
the economist Paul Douglas who used it to consider the relative importance of
the two input factors, labour and capital, in manufacturing output in the USA
over the period 1899 to 1922. In their original model, Cobb and Douglas
restrict the output-elasticity parameters α1 and α2 to the range αi∈(0,1) and to
sum to one, which implies constant returns to scale. The function is thus
Y=γxα11x1−α12
where x1 and x2 stand for labour and capital, respectively. Taking the natural
logarithm of both sides of the equation yields
lnY=lnγ+α1lnx1+(1−α1)lnx2
Such that for data on output, labour and capital, the parameters γ and α1 can
be estimated using Ordinary Least Squares. Based on their data, Cobb and
Douglas find a value of 0.75 for α1, implying that labour accounted for three
quarters of the value of US manufacturing output (capital accounting for the
remaining quarter) over the period studied. Their estimate for the efficiency
parameter γ is 1.01, which, since it is greater than 1, reflects the positive
effects of unobservable forces on production through the combination of labour

14. and capital.The multiplicative nature of a Cobb-Douglas production function,
assuming positive values for αi, means that the inputs are complements in
production. In the standard model of labour and capital, increasing the amount
of capital increases production not only directly, but also indirectly through its
impact on the productivity of labour. Mathematically, the cross-partial
derivative of production output Y with respect to labour x1 and capital x2 is
positive. Furthermore, due to the assumption that αi∈(0,1), the second-order
partial derivatives of production output with respect to labour and with respect
to capital are both negative, implying diminishing marginal returns for each
input alone. Simply adding either more labour or more capital (but not both) to
the production process increases output, though at a diminishing rate.
Furthermore, the elasticity of substitution between the inputs is constant and
equal to one due to the functional form. A two-input Cobb-Douglas production
function can be represented graphically in the form of isoquants: combinations
of both inputs for which the output is constant. There are four such isoquants
in the graph here for the (constant) output levels Y1¯¯¯¯¯, Y2¯¯¯¯¯, Y3¯¯¯¯¯ and
Y4¯¯¯¯¯. The further the isoquant from the origin, the greater the level of
output Y4¯¯¯¯¯>Y3¯¯¯¯¯>Y2¯¯¯¯¯>Y1¯¯¯¯¯. Which precise combination of the
inputs x1 and x2 is optimal for production is determined by the budget
available to the producer as well as the cost ratio of input x2 to input x1 which
can be included in the graph in the form of an is cost line (see the article on
elasticity of substitution).
Cobb-Douglas
Cobb and Douglas themselves acknowledged that their production function
does not rest on solid theoretical foundations, nor should it be understood as a
law of production; it merely represents a statistical approximation of the
observed relationships between production inputs and output. Nevertheless, its
simple mathematical properties are attractive to economists and have led to it
becoming a standard in microeconomic theory over the past century.
Answer 9
Expansion path is a graph which shows how a firm’s cost minimizing input mix
changes as it expands production. It traces out the points of tangency of the
isocost lines and isoquants.
An expansion path provides a long-run view of a firm’s production decision and
can be used to create its long-run cost curves. Since we define long-run as a
time period in which a firm can change all its inputs including capital, the
expansion path depends on how the firm changes its input mix.

15. An isocost line plots such combinations of inputs at which the firm’s total cost
is constant. An isoquant represents such combination of inputs which generate
the same amount of output. A profit-maximizing firm is interested in producing
maximum output at minimum cost. This occurs at a point at which its isocost
line is tangent to the relevant isoquant. As the firm increases its input budget
while the unit costs of inputs remain the same, the firm’s isocost lines shift
outwards such that they touch higher and higher isoquants. If we connect all
such points at which isocost lines are tangent to the isoquants, we get the
firm’s expansion path.
Normal Input vs Inferior Input
A firm’s expansion path tells us whether the firm’s inputs are normal inputs or
inferior inputs.
An input is a normal input if the firm increases its proportion in its production
mix as it increases production. An inferior input, on the other hand, is an
input whose proportion decreases as the firm switches to other inputs at
higher production level. The expansion path slopes away from an inferior input
i.e. it has negative slope. But in case of a normal input, the expansion path has
a positive slope.
Example
Assume you manage a fast-food chain which has hundreds of outlets. You
must decide whether to install self-service kiosks or hire more labor as you
expand your chain. If each kiosk cost $500 and each labor hour costs $15, the
following graph shows your cost-minimizing and production-maximizing
combination of capital and labor at different production levels
Answer (10)
Define the following
A) Marginal cost is an important factor in economic theory because a
company that is looking to maximize its profits will produce up to the
point where marginal cost (MC) equals marginal revenue (MR). Beyond
that point, the cost of producing an additional unit will exceed the
revenue generated.
Marginal cost is the additional cost incurred for the production of an
additional unit of output. The formula is calculated by dividing the
change in the total cost by the change in the product output.

16. Marginal cost refers to the increase or decrease in the cost of producing
one more unit or serving one more customer. It is also known as
incremental cost.
Marginal costing is useful in profit planning; it is helpful to determine
profitability at different level of production and sale. It is useful in
decision making about fixation of selling price, export decision and make
or buy decision. Break even analysis and P/V ratio are useful techniques
of marginal costing.
Advantages of Marginal Cost Pricing
Marginal cost pricing has the following advantages:
 Earn additional profits - A company can earn additional profits by
attracting extremely price-sensitive customers with occasional offerings
of low prices.
 Increase market penetration - Marginal cost pricing can be used to
initially gain entry into a new market by attracting new price-conscious
buyers.
 Increase accessory sales - In some cases, a company can sell a
product with a lower price from marginal costing but still earn more
profits by selling related products that have higher profit margins to the
consumer.
 Eliminate excess capacity or inventory - Marginal cost pricing is
useful to move excess inventory or capacity quickly.
 Smooth fluctuations in demand - If demand slows down, a company
can temporarily reduce prices to attract bargain hunters.
 Stay price-competitive in the short-term - Marginal cost pricing is
a valuable tool to use when competitors lower their prices in an attempt
to gain market share.
Disadvantages of Marginal Cost Pricing
The disadvantages of marginal cost pricing are as follows:
 Ignores current market prices - Marginal cost pricing does not
consider prevailing market prices. It is strictly based on variable costs.
 Does not build customer loyalty - Customers who take advantage of
marginal cost prices are usually price-sensitive and will not become
loyal, long-term purchasers.

17.  Not sustainable for the long-term - At some point, the company will
have to sell enough product at sufficient price points to cover fixed
expenses and produce a profit.
 Could be difficult to raise prices later - Consumers can come to
expect lower prices and resist raising prices at a later date.
 May shift higher-paying customers - Customers who are used to
paying normal prices may shift to the discounted price market and
become reluctant to return to regular prices. Price markets should be
separated to prevent this from happening.
- Marginal cost pricing strategy is an effective tool when used in the
short-term. It can help a company maintain its marketing position
but sacrifices profit and will not be effective in the long-term.
B) Opportunity Cost and Examples:
Opportunity cost is the value of something when a particular course of
action is chosen. Simply put, the opportunity cost is what you must forgo
in order to get something. The benefit or value that was given up can
refer to decisions in your personal life, in a company, in the economy, in
the environment, or on a governmental level.
Examples of Opportunity Cost:
Someone gives up going to see a movie to study for a test in order to get a
good grade. The opportunity cost is the cost of the movie and the
enjoyment of seeing it.
C) Explain the concepts: AFC, AVC, ATC and MC:
There are four: marginal cost, MC; average total cost, ATC; average
variable cost, AVC; and average fixed cost, AFC. The average
curves are the total counterparts divided by the output level, i.e.,
ATC = TC/q; AVC = TVC/q; and AFC = TFC/q
Remember: ATC = FC/TP + VC/TP. In the rising portion of the ATC
curve, AVC is increasing faster than AFC is falling, thus pushing the ATC
curve up. Marginal cost (MC) is the cost of producing another unit of
output; that is, it is the cost of the additional labor required to produce
another unit.
A fixed cost per unit of output is known as the AFC, while a variable cost
per unit of output is known as the AVC. Bob’s Bakery can produce 100
loaves with FC = 40, VC = 500, and TC = 540, as we said earlier.
Accordingly, ATC = 540/100 = 5, which is 540/100 = 540/100 = 5. In
addition, AFC equals 40/100. A value of 4 and an AVC of 500/100
equals a value of 5.

18.  How Do You Calculate Afc?
By dividing total fixed costs by the output level, the AFC is calculated.
We must decide whether a cost is fixed or variable based on whether it is
short-run or long-run. It is only relevant to the short run that average
fixed costs are relevant.
 What Is The Formula For Afc In Economics?
A pen factory with a fixed cost of *5,000/- and 500 pens will produce an
average fixed price of *10/- per unit if the fixed cost is *5,000/-.
 How Do You Find Afc With Total Cost?
By dividing the total fixed costs by the number of production units over a
fixed period, we can calculate the average fixed cost of a product. If you
only want to determine how fixed costs affect the fixed cost per unit, the
division method is useful.
 How Do You Calculate Average Total Cost In Economics?
The average total cost is calculated by multiplying the fixed costs plus
the variable costs by the number of units produced.
Variable costs are added to total fixed costs.
Cost change – new cost – old cost.
The new quantity equals the old quantity.
 How Do You Find Afc On A Graph?
As shown in the left-hand graphic, firms must combine fixed and
variable inputs to produce output. The average fixed cost (AFC) is the
difference between total fixed costs (FC) and total product (TP). Total
fixed costs do not vary with output, but as the total product (TP)
increases, the average fixed cost decreases.
 How Do You Calculate Atc In Economics?
The average total cost (ATC) is calculated by dividing the total cost by the
total quantity produced.
 How Do You Find Avc From Tc And Mc?
A fixed cost (FC) is 5 if the TC is 0 output. Thus, if we subtract 5 from
the TCs for all the subsequent output levels, we will get the VC at each
one. The next step is to multiply AVC by VC.
 How Do You Find Atc Avc And Afc?
A variable cost per unit of output is the average variable cost (AVC). The
ATC is TC / Q; the AFC is TFC / Q; the AVC is TVC / Q.

19.  How Do You Calculate Average Fixed Manufacturing Cost?
Divide your total cost of production by the number of units you produced
to get your variable costs. Using this fixed cost formula, you can figure
out how much you will spend on this item.
 How Do You Find Afc Avc Atc And Mc?
A fixed cost per unit of output is known as the average fixed cost (AFC). A
variable cost per unit of output is the average variable cost (AVC). The
ATC is TC / Q; the AFC is TFC / Q; the AVC is TVC / Q.
 What Is Afc Curve?
As fixed costs increase in quantity, the average fixed costs AFC curve will
slope downward. A difference between ATC and AVC is equal to the
vertical difference between AFC and AMC. When MC>AVC are combined,
the average variable costs increase when an additional unit is produced.
 How Do You Find AFC From Total Cost?
By dividing total fixed costs by the output level, the AFC is calculated.
 How Do You Find Total Product From Total Cost?
The total product is equal to the output or the quantity of goods.
The average variable cost (AVC) is equal to the total variable cost /
quantity of goods (this formula is cyclic with the TVC formula).
The average fixed cost (AFC) is equal to the average fixed cost (AVC) of
the ATC.
AVC + AFC equals the quantity of goods divided by the total cost.
 How Do You Calculate The Average Cost?
In order to calculate average prices, the sum of the values and the
number of prices examined are taken together.
 How Do You Calculate Atc From Fc And Vc?
The ATC is the TC/TP equation. The second method is to divide TC into
fixed costs (FC) and variable costs (VC), divide each of those by total
product and add them to ATC: FC/TP + VC/TP.
D) Explain briefly the various types of costs with suitable
examples.
 Direct Costs
Direct costs are related to producing a good or service. A direct
cost includes raw materials, labor, and expense or distribution
costs associated with producing a product. The cost can easily be
traced to a product, department, or project. For example, Ford
Motor Company (F) manufactures cars and trucks. A plant worker
spends eight hours building a car. The direct costs associated with

20. the car are the wages paid to the worker and the cost of the parts
used to build the car.
 Indirect Costs
Indirect costs, on the other hand, are expenses unrelated to
producing a good or service. An indirect cost cannot be easily
traced to a product, department, activity, or project. For example,
with Ford, the direct costs associated with each vehicle
include tires and steel. However, the electricity used to power the
plant is considered an indirect cost because the electricity is used
for all the products made in the plant. No one product can be
traced back to the electric bill.
Fixed Costs
Fixed costs do not vary with the number of goods or services a company
produces over the short term. For example, suppose a company leases a
machine for production for two years. The company has to pay $2,000
per month to cover the cost of the lease, no matter how many products
that machine is used to make. The lease payment is considered a fixed
cost as it remains unchanged.
Variable Costs
Variable costs fluctuate as the level of production output changes,
contrary to a fixed cost. This type of cost varies depending on the
number of products a company produces. A variable cost increases as
the production volume increases, and it falls as the production volume
decreases. For example, a toy manufacturer must package its toys before
shipping products out to stores. This is considered a type of variable cost
because, as the manufacturer produces more toys, its packaging costs
increase, however, if the toy manufacturer's production level is
decreasing, the variable cost associated with the packaging decreases.
Operating Costs
Operating costs are expenses associated with day-to-day business
activities but are not traced back to one product. Operating costs can be
variable or fixed. Examples of operating costs, which are more commonly
called operating expenses, include rent and utilities for a manufacturing
plant. Operating costs are day-to-day expenses, but are classified
separately from indirect costs – i.e., costs tied to actual production.
Investors can calculate a company's operating expense ratio, which
shows how efficient a company is in using its costs to generate sales.

21. Opportunity Costs
Opportunity cost is the benefits of an alternative given up when one
decision is made over another. This cost is, therefore, most relevant for
two mutually exclusive events. In investing, it's the difference in return
between a chosen investment and one that is passed up. For companies,
opportunity costs do not show up in the financial statements but are
useful in planning by management.
For example, a company decides to buy a new piece of manufacturing
equipment rather than lease it. The opportunity cost would be the
difference between the cost of the cash outlay for the equipment and the
improved productivity vs. how much money could have been saved in
interest expense had the money been used to pay down debt.
Sunk Costs
Sunk costs are historical costs that have already been incurred and will
not make any difference in the current decisions by management. Sunk
costs are those costs that a company has committed to and are
unavoidable or unrecoverable costs. Sunk costs are excluded from future
business decisions.
Controllable Costs
Controllable costs are expenses managers have control over and have the
power to increase or decrease. Controllable costs are considered so when
the decision of taking on the cost is made by one individual. Common
examples of controllable costs are office supplies, advertising expenses,
employee bonuses, and charitable donations. Controllable costs are
categorized as short-term costs as they can be adjusted quickly.
E) Discuss the short run cost output relationship with the graph:
COST OUTPUT RELATIONSHIP IN THE SHORT RUN
In the short-run a change in output is possible only by making changes
in the variable inputs like raw materials, labour etc. Inputs like land and
buildings, plant and machinery etc. are fixed in the short-run. It means
that short-run is a period not sufficient enough to expand the quantity of
fixed inputs. Thus Total Cost (TC) in the short-run is composed of two
elements – Total Fixed Cost (TFC) and Total Variable Cost (TVC).
TFC remains the same throughout the period and is not influenced by
the level of activity. The firm will continue to incur these costs even if the
firm is temporarily shut down. Even though TFC remains the same fixed
cost per unit varies with changes in the level of output.

22. On the other hand TVC increases with increase in the level of activity,
and decreases with decrease in the level of activity. If the firm is shut
down, there are no variable costs. Even though TVC is variable, variable
cost per unit is constant.
So in the short-run an increase in TC implies an increase in TVC only.
Thus:
TC = TFC + TVC
TFC = TC – TVC
TVC = TC – TFC
TC = TFC when the output is zero.
The graph below shows Short-run cost output relationship.
In the graph X-axis measures output and Y-axis measures cost.
TFC is a straight line parallel to X-axis, because TFC does not change
with increase in output.
TVC curve is upward rising from the origin because TVC is zero when
there is no production and increases as production increases. The shape
of TVC curve depends upon the productivity of the variable factors. The
TVC curve above assumes the Law of Variable Proportions, which
operates in the short-run.
TC curve is also upward rising not from the origin but from the TFC line.
This is because even if there is no production the TC is equal to TFC. It
should be noted that the vertical distance between the TVC curve and TC
curve is constant throughout because the distance represents the
amount of fixed cost which remains constant. Hence TC curve has the
same pattern of behaviour as TVC curve.
F) Derive long run total cost curve:
To derive the long-run total cost function, we take the pairs of total cost
and quantity from the expansion path. “The long-run total cost function
shows the lowest total cost of producing each quantity when all factors of
production are variable.”
Graphy

23. G) What is the relationship between AC and MC?:
Relationship between AC and MC
There is a close relationship between AC and MC. MC is the change in TC
resulted from the change in the production of one more unit of output
whereas AC is the total cost divided by the output. Both AC and MC are
derived from TC.
Symbolically;
MC = ∆TC / ∆Q
AC = TC / Q
The relationship between these two can be explained with the help of the
following diagram:
relationship-between-ac-and-mc
In the above figure, SMC represents the short-run marginal cost curve
and SAC represents the short-run average cost curve. SMC and SAC
intersect each other at the minimum point of SAC. It lies to the right of
A, the minimum point of SMC I.e point B. The relationship between these
two can be summarized as follows:
Both AC and MC curve are calculated from the total cost.
Both AC and MC are ‘U’ shaped.
When AC is falling, the MC curve lies below AC and MC falls faster than
AC.
When AC is rising, the MC curve lies above the AC and MC rises faster than AC.
When AC is minimum, MC=AC
MC intersects at the minimum point of AC.
MC cuts AC from below.
H) Give reasons for the U shape of long run AC curve.
The reasons behind the U-shaped, long-run average cost curve are;
The long-run cost curves are U-shaped due to economies of scale and
diseconomies of scale. If a firm has high fixed costs, the increasing
output will lead to lower average costs. This will result in economies of
scale.
Long-run Average Cost Curve:
Average costs basically refer to the total economic costs of production
divided by the total quantity of output. Total economic costs can either
be fixed or variable. They are variable if they change in proportion to the

24. quantity of goods or services produced for example raw materials. They
are fixed if they do not depend on the quantity of the goods and services
produced, as most of them are time related such as rentals.
Long-run average total cost curves are U-shaped mainly because of
economies of scale, constant returns to scale, and diseconomies of scale.
Economies of scale explain the falling segment, while diseconomies of
scale explain the rising segment. The minimum segment is explained by
the constant returns to scale.
Economies of scale are cost advantages that firms enjoy because of their
volume of production or scale of operation. Thus, economies of scale can
be as a result of efficient machinery, greater division of labor, or
specialization such that employees become better at specific tasks. These
economies of scale lead to increasing returns to scale, whereby output
increases by more than proportional increase in inputs. With this, the
long-run average costs curve is declining.
As a firm increases in size, having utilized all efficient machinery and
division and specialization of labor, it will reach a point of constant
returns to scale where both average costs and output increase by the
same proportion. This will be the minimum point of the long-run average
cost curve.
Beyond the minimum point, there will be a scenario of diseconomies of
scale because any increase in output or any efforts by firm to expand in
size means the firm experience in higher costs. Diseconomies of scale
might originate from coordination problems once firms become too large.
Also, as firms face diseconomies of scale, they also face decreasing
returns to scale, where output increases by less than proportionate
change in inputs. This is the rising segment of the long-run average cost
curve.
I) Distinguish between economies of scale and diseconomies of
scale with a graph:
Economies of scale are when the cost per unit of production (Average
cost) decreases because the output (sales) increases. Diseconomies of
scale are when the cost per unit of production (Average cost) increases
because the output (sales) increases. Growth brings both advantages and
disadvantages to a business.

25. J) List out the factors that cause economies and diseconomies of
scale:
Economies of scale refer to the cost advantage brought about by an
increase in the output of a product. Economies of scale arise due to the
inverse relationship between the per-unit fixed cost and the quantity
produced – the greater the production, the lower the fixed costs per unit.
This is because the production costs have been spread out over a large
number of goods. As a result, synergies and operational efficiency cause
a reduction in variable costs. From this, economies of scale can be
divided into two categories: internal economies of scale: arising from
within a company; and external economies of scale: arising from
extraneous factors such as the size of the industry.
Economies of scale can result from: increasing returns to scale; division
of labor and good management; ability to afford more expensive and
reliable equipment; effective waste reduction and lowering costs; utilizing
market information maximally; and obtaining discounted prices.
Example of Economies of Scale
A family wants to print wedding invitation cards for their daughter’s
wedding. Printing 500 cards costs $1,000. However, printing 1,000
invitation cards will cost them $1,500. Therefore, while printing 500
cards will cost them $2 per invitation card, printing 1,000 copies will
cost $1.5 per card. This is because the price will fall after the initial set-
up costs of the printer have been covered. As a result, this leaves only a
marginal extra printing cost for every additional card.
Diseconomies of Scale
Diseconomies of scale occur when the cost per unit increases with an
increase in the quantity produced. This means that any attempt by a
firm to increase its output will transcend to a corresponding increase in
the unit cost associated with the unit increase in output.
This usually happens when a firm becomes too big. It is represented on
the following graph when going from Q1 to Q2. Beyond point Q1, which
is the ideal firm size, producing more goods increases per-unit costs.
Diseconomies-of-scale
Some factors that may lead to diseconomies of scale include: decreasing
returns to scale; a firm may become too large to properly manage itself;
overlapping of business functions and duplication of product lines; and
higher resource prices resulting from supply constraints

26. Answer (11)
Mention the characteristics of monopoly, oligopoly, and monopolistic
competitive and perfect competitive market structure and make comparison.
1. Perfect Competition
Perfect competition occurs when there is a large number of small
companies competing against each other. They sell similar products
(homogeneous), lack price influence over the commodities, and are free to
enter or exit the market.
Consumers in this type of market have full knowledge of the goods being
sold. They are aware of the prices charged on them and the product
branding. In the real world, the pure form of this type of market
structure rarely exists. However, it is useful when comparing companies
with similar features. This market is unrealistic as it faces some
significant criticisms described below.
No incentive for innovation: In the real world, if competition exists and a
company holds a dominant market share, there is a tendency to increase
innovation to beat the competitors and maintain the status quo.
However, in a perfectly competitive market, the profit margin is fixed, and
sellers cannot increase prices, or they will lose their customers.
There are very few barriers to entry: Any company can enter the market
and start selling the product. Therefore, incumbents must stay proactive
to maintain market share.
2. Monopolistic Competition
Monopolistic competition refers to an imperfectly competitive market with
the traits of both the monopoly and competitive market. Sellers compete
among themselves and can differentiate their goods in terms of quality
and branding to look different. In this type of competition, sellers
consider the price charged by their competitors and ignore the impact of
their own prices on their competition.
When comparing monopolistic competition in the short term and long
term, there are two distinct aspects that are observed. In the short term,
the monopolistic company maximizes its profits and enjoys all the
benefits as a monopoly.

27. The company initially produces many products as the demand is high.
Therefore, its Marginal Revenue (MR) corresponds to its Marginal Cost
(MC). However, MR diminishes over time as new companies enter the
market with differentiated products affecting demand, leading to less
profit.
3. Oligopoly
An oligopoly market consists of a small number of large companies that
sell differentiated or identical products. Since there are few players in the
market, their competitive strategies are dependent on each other.
For example, if one of the actors decides to reduce the price of its
products, the action will trigger other actors to lower their prices, too. On
the other hand, a price increase may influence others not to take any
action in the anticipation consumers will opt for their products.
Therefore, strategic planning by these types of players is a must.
In a situation where companies mutually compete, they may create
agreements to share the market by restricting production, leading to
supernormal profits. This holds if either party honors the Nash
equilibrium state and neither is tempted to engage in the prisoner’s
dilemma. In such anagreement, they work like monopolies. The collusion
is referred to as cartels.
4. Monopoly
In a monopoly market, a single company represents the whole industry.
It has no competitor, and it is the sole seller of products in the entire
market. This type of market is characterized by factors such as the sole
claim to ownership of resources, patent and copyright, licenses issued by
the government, or high initial setup costs.
All the above characteristics associated with monopoly restrict other
companies from entering the market. The company, therefore, remains a
single seller because it has the power to control the market and set
prices for its goods.

28. Answer 12
What is Risk Transfer?
Risk transfer refers to a risk management technique in which risk is
transferred to a third party. In other words, risk transfer involves one party
assuming the liabilities of another party. Purchasing insurance is a common
example of transferring risk from an individual or entity to an insurance
company.
Risk Transfer
How It Works
Risk transfer is a common risk management technique where the potential loss
from an adverse outcome faced by an individual or entity is shifted to a third
party. To compensate the third party for bearing the risk, the individual or
entity will generally provide the third party with periodic payments.
The most common example of risk transfer is insurance. When an individual or
entity purchases insurance, they are insuring against financial risks. For
example, an individual who purchases car insurance is acquiring financial
protection against physical damage or bodily harm that can result from traffic
incidents.
As such, the individual is shifting the risk of having to incur significant
financial losses from a traffic incident to an insurance company. In exchange
for bearing such risks, the insurance company will typically require periodic
payments from the individual.
Methods of Risk Transfer
There are two common methods of transferring risk:
1. Insurance policy
As outlined above, purchasing insurance is a common method of
transferring risk. When an individual or entity is purchasing insurance,
they are shifting financial risks to the insurance company. Insurance
companies typically charge a fee – an insurance premium – for accepting
such risks.
2. Indemnification clause in contracts
Contracts can also be used to help an individual or entity transfer risk.
Contracts can include an indemnification clause – a clause that ensures
potential losses will be compensated by the opposing party. In simplest

29. terms, an indemnification clause is a clause in which the parties involved
in the contract commit to compensating each other for any harm,
liability, or loss arising out of the contract.
For example, consider a client that signs a contract with an
indemnification clause. The indemnification clause states that the
contract writer will indemnify the client against copyright claims. As
such, if the client receives a copyright claim, the contract writer would (1)
be obliged to cover the costs related to defending against the copyright
claim, and (2) be responsible for copyright claim damages if the client is
found liable for copyright infringement.
Risk Transfer by Insurance Companies
Although risk is commonly transferred from individuals and entities to
insurance companies, the insurers are also able to transfer risk. This is
done through an insurance policy with reinsurance companies.
Reinsurance companies are companies that provide insurance to
insurance firms.
Similar to how individuals or entities purchase insurance from insurance
companies, insurance companies can shift risk by purchasing insurance
from reinsurance companies. In exchange for taking on this risk,
reinsurance companies charge the insurance companies an insurance
premium.
Risk Transfer vs. Risk Shifting
Risk transfer is commonly confused with risk shifting. To reiterate, risk
transfer is passing on (“transferring”) risk to a third party. On the other
hand, risk shifting involves changing (“shifting”) the distribution of risky
outcomes rather than passing on the risk to a third party.
For example, an insurance policy is a method of risk transfer.
Purchasing derivative contracts is a method of risk shifting.