Questions for Review with Answers
Chapter 10. Supply Theory I. The Supply Curve and Cost Behaviour
I. Preliminary Remark
Chapter 10 – Question 1
1) Do you remember the analogies between demand theory and supply theory?
* The main analogies are that the definitions of quantity supplied/demanded and of supply and demand are completely symmetrical. Movements along the curves are ascribed in either theory to price changes; shifts of the curves are explained by changes in exogenous factors.
The slope of the demand curve is explained by the law of demand and the law of diminishing utility. The slope of the supply curve is explained by the law of supply and the law of diminishing returns. Price elasticity of supply and demand is measured by analogous formulas.
II. Theoretical Premises of Supply Theory
Chapter 10 – Question 2
What are the criteria that the model firm of microeconomics must fulfil?
* The competitive firm is a small, price-taking business. It is part of an industry with easy entry and exit; it is confronted with a large number of competitors but at the same time with infinite demand for its product. It sells its product at marginal cost.
Chapter 10 – Question 3
Why is the demand curve for the model firm a horizontal line?
* Because the firm is supposed to be faced with infinite demand. It can sell as many units as it wishes at the price determined by the market.
III. The Basics
Chapter 10 – Question 4
Distinguish quantity supplied and supply.
* Quantity supplied: (1) the quantity that suppliers are able and willing to supply at a certain price, (2) one point on the supply curve.
Supply: (1) the quantities that supplier are able and willing to supply at any possible price, (2) the whole supply curve.
Chapter 10 – Question 5
Distinguish endogenous and exogenous variables in supply theory.
* Endogenous variables are price and quantity supplied. Exogenous variables are prices of inputs, productivity, technology, expectations of price changes.
Chapter 10 – Question 6
What causes a movement along the supply curve?
* A change in price.
Chapter 10 – Question 7
And what causes a shift of the supply curve?
* Changes in exogenous variables.
Chapter 10 – Question 8
Explain why the supply curve slopes upwards from left to right.
* There are two reasons: (1) The law of supply, which postulates that quantity supplied rises as price rise. (2) The law of diminishing returns, which states that costs per unit rise as output is expanded without increasing all inputs simultaneously.
Chapter 10 – Question 9
What is market supply?
* Market supply is supply of an industry's product in a specified region, for instance, the local or regional market for red tulips.
Chapter 10 – Question 10
What happens to the market supply curve for red tulips when bad weather destroys part of the red-tulip harvest?
* Remember that any change other than a change in price shifts the supply curve. A destruction of part of the red-tulip harvest is a change in an exogenous factor, which shifts the supply curve to the left. A lower quantity is sold at any price.
IV. Price Elasticity of Supply
Chapter 10 – Question 11
What is price elasticity of supply?
* A more than proportionate response of quantity supplied to changes in price.
Chapter 10 – Question 12
Write down the fraction to calculate it.
* Percentage change in quantity supplied/Percentage change in price. Supply is price elastic when the numerator exceeds the denominator.
Chapter 10 – Question 13
Why are the slope of the supply curve and elasticity not identical?
* Because they are measured by different formulas.
Slope of the supply curve: Change on y-axis/Change on x-axis
Elasticity: Percentage change in quantity supplied/percentage change in price.
Chapter 10 – Question 14
What does the slope of a linear supply curve tell you about elasticity?
* The steeper it is, the more inelastic is supply. It is completely inelastic when the supply curve is a vertical line. At any price, the same quantity is supplied.
Chapter 10 – Question 15
How do you calculate supply elasticity between two points on the supply curve?
| * The formula is: | Change in quantity : | Change in price |
| Average quantity | Average price |
V. Cost Behaviour and Cost Curves
Chapter 10 – Question 16
Define
A. AFC
B. AVC
C. ATC
D. MC
E. Sunk costs
* A. AFC = Fixed costs per unit.
* B. AVC = Variable costs per unit.
* C. ATC = Total costs per unit.
* D. MC= increase in total cost incurred by producing one extra unit.
* E. Sunk costs = costs that cannot be recovered.
Chapter 10 – Question 17
What are total costs for 10 units according to the following cost function: TC = 8Q.
* 80. (8x10).
Chapter 10 – Question 18
State and explain the viability rule.
* A firm must shut down temporarily if price does not cover AVC. It is impossible to produce anything without inputs. This rule assumes fixed costs to be sunk costs.
A firm must shut down definitively if price does not cover ATC. This rule assumes that fixed costs must be covered by revenues.
VI. The Reasons for the Behaviour of Costs
Chapter 10 – Question 19
Draw and explain the production function.
* The production function is the relationship between inputs used and output gained. It is illustrated by a curve with output on the vertical axis and inputs on the horizontal axis. The curve slopes upwards from left to right; output rises as inputs rise, but it usually does not rise by the same proportion, which is why the curve is not a straight line.
Chapter 10 – Question 20
Distinguish between the production function and the PPF.
* The production function has output on the vertical axis and inputs on the horizontal axis. The PPF has one commodity on either axis.
Chapter 10 – Question 21
Explain the law of diminishing returns.
* The law of diminishing returns states that returns (increases in output) diminish when one or some production factors are held constant while others are increased. This is another way of saying that marginal costs rise as output is expanded.
Chapter 10 – Question 22
What is the difference between returns and returns to scale?
* Returns occur after some but not all inputs have been increased.
Returns to scale occur after all inputs have been increased.
Chapter 10 – Question 23
Define
A. economies of scale
B. diseconomies of scale
C. economies of scope
* A. Economies of scale are financial economies that lower long-term ATC as output is increased. Of scale stands for of size of output.
* B. Diseconomies of scale are financial diseconomies that increase long-term ATC as output is increased.
* C. Economies of scope are financial economies resulting from the fact that the simultaneous production of two goods is cheaper than their separate production.
VII. Back to the Firm's Supply Curve
Chapter 10 – Question 24
Define efficient scale.
* Scale stands for size of output. Efficient scale is the size of output at which average total costs are minimised. To put the same otherwise, it is the size of output for which a firm is best suited and equipped. Graphically, efficient scale is the size of output at which the marginal cost curve intersects the average total cost curve.
Chapter 10 – Question 25
What happens to fixed factors in the long term?
* They become variable factors.
Chapter 10 – Question 26
Draw a short-term and a long-term supply curve and explain the
difference between them in words.
* They start at different levels, which is due to the viability rule. The short-term curve starts above the AVC curve. The long-term curve starts above the ATC curve. In the short term, fixed costs are sunk costs, in the long term they are not.
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