Fundamental Question Review on : Law of Diminishing Marginal State

Case Studies Review done by My Assignment Help: Law of Diminishing Marginal State

Question 1:

The law of diminishing marginal returns states that if only one of the factors of production is increased, while the other factors are kept constant then the marginal product of each unit of input will decline as the amount of that input is increased, holding all other inputs constant (Samuelson, Nordhaus, 2000).

So if one of the factors of production is fixed and the other is variable then the marginal product of the variable factor will decrease as the number of units of variable factor is increased.

An example of this is that of laborers working on a fixed unit of land. As the number of units of laborers working on the same size of land is increased the marginal productivity of labor goes on decreasing.

Decreasing returns to scale occurs when an increase in inputs brings less than a proportionate increase in output. So if the input is increased by more than twice, the output will increase by less than twice.  The main reason for decreasing returns to scale or diseconomies of scale is managerial and control diseconomies. As the scale of operations increase managerial inefficiencies set in. The phenomenon of diseconomies of scale has been observed in many activities including electricity generation, where firms found that when the size of plants grew too large, the risk of plant failure too grew very large (Samuelson, Nordhaus, 2000).

The main difference between diminishing marginal returns and decreasing returns to scale is that in case of decreasing returns to scale all the factors of production are varied while in case of diminishing marginal returns only one of the factors of production is varied while all other factors are kept constant.

Question 2:

In an oligopoly, the whole output of the industry is supplied by a few firms only. Firms in the jeans industry are in such an oligopoly. This oligopoly is non-collusive because the firms do not collude and when a firm increases its price the others do not follow it, but when a firm cuts its price the other firms follow it (A Koutsoyiannis, 2010)

The firms in the jeans industry are competing against each other. Each firm’s product differentiation comes from its unique brand, which gives it a downward sloping demand curve.

A3.) The utility of perfect competition model lies in the understanding that it provides about the ideal scenario of perfect competition where the firms are price takers; there are no barriers to entry and exit; there is no product differentiation and there is no asymmetry of information between buyers and sellers. Also many markets like those of commodities may not be perfectly competitive but are very near to it.

The long run equilibrium of a firm in a perfectly competitive industry occurs at the intersection e of long run average cost curve (LAC), long run marginal cost curve (LMC) and the demand curve (P).In the long run equilibrium, the firm will earn zero economic profits.

For a monopolist:

MR = P( 1- 1/e)

If the monopolist supplies on the inelastic portion of the demand curve, then 1/e is greater than 1 as e < 1.

In this case MR will be less than zero. Now the profit maximizing condition for a monopolist is:

MR = MC

Now MC (marginal cost) can never be less than zero, hence MC = MR condition will not be satisfied if the monopolist produces in the inelastic portion of the demand curve

b) i)In case the marginal revenue exceeds marginal cost, then the monopolist will increase the output till marginal revenue becomes equal to marginal cost.

ii)In case marginal cost exceeds marginal revenue, the monopolist will cut down its output till marginal revenue increases and becomes equal to marginal costs.

Question 5

A recent microeconomic reform in Australia happened when the Australian Parliament in March 2012 has passed the resolution of imposing a 30 per cent additional tax on mining companies in coal and iron ore production.

The companies which are likely to be affected by this new tax include BHP Billiton Ltd, Rio Tinto Ltd and Xstrata Plc.

The tax is meant to distribute some of the profits that the commodities boom in the recent past has brought to large mining companies in Australia.

b) The success of this micro-economic reform will depend on whether it will succeed in achieving its objective. The new tax intends to raise A $ 10.6 billion in the first three years. A$ 6 billion of this will go in infrastructure spending while the remaining will be used for making higher payments into pension funds.

References;

Paul Samuelson, William Nordhaus, 2000, Economics, Prentice Hall

A Koutsoyiannis, 2010, Modern Microeconomics, Prentice Hall

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