CA Foundation P4 · Chapter 3
Theory of Production and Cost MCQs with Answers
15 multiple-choice questions on Theory of Production and Cost for CA Foundation P4 Business Economics. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
A production function expresses:
- A) The technical relationship between physical inputs and physical output
- B) The relationship between price and quantity demanded
- C) The relationship between cost and revenue
- D) The relationship between output and its price
Show answer & explanation
Answer: A) The technical relationship between physical inputs and physical output
A production function shows the maximum output that can be obtained from given quantities of inputs with a given state of technology, i.e., Q = f(L, K, ...). It is a technical (physical) relationship, not a monetary one.
Question 2
Under the law of variable proportions, a rational producer will operate in:
- A) Stage I, where average product of the variable factor is rising
- B) Stage III, where marginal product of the variable factor is negative
- C) Any stage, depending on the price of output
- D) Stage II, where both average and marginal products of the variable factor are falling but marginal product is positive
Show answer & explanation
Answer: D) Stage II, where both average and marginal products of the variable factor are falling but marginal product is positive
In Stage I the fixed factor is under-utilised and AP of the variable factor is still rising, so it pays to add more of it. In Stage III MP is negative, so adding the variable factor reduces total output. Hence the rational stage is Stage II, from maximum AP to the point where MP is zero.
Question 3
Total product of labour (with fixed capital) is as follows: 1 worker: 10 units; 2 workers: 24; 3 workers: 36; 4 workers: 44; 5 workers: 48. The marginal product of the 4th worker is:
- A) 11 units
- B) 44 units
- C) 8 units
- D) 12 units
Show answer & explanation
Answer: C) 8 units
MP of the nth worker = TPn - TPn-1. MP of the 4th worker = 44 - 36 = 8 units. 11 units is the average product of 4 workers (44/4), and 12 units is the MP of the 3rd worker (36 - 24).
Question 4
If all inputs are doubled and output increases three times, the firm is experiencing:
- A) Constant returns to scale
- B) Decreasing returns to scale
- C) Increasing returns to scale
- D) Diminishing returns to a variable factor
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Answer: C) Increasing returns to scale
Returns to scale refer to the long run when all inputs change in the same proportion. Output rising more than proportionately (3 times when inputs double) indicates increasing returns to scale. Diminishing returns to a factor is a short-run concept with at least one fixed input.
Question 5
For the Cobb-Douglas production function Q = A L^0.6 K^0.5, returns to scale are:
- A) Constant, since each exponent is less than one
- B) Increasing, since the sum of the exponents is 1.1
- C) Decreasing, since each exponent is less than one
- D) Constant, since the function is homogeneous
Show answer & explanation
Answer: B) Increasing, since the sum of the exponents is 1.1
For Q = A L^a K^b, returns to scale depend on a + b. Here 0.6 + 0.5 = 1.1 > 1, so increasing returns to scale. If all inputs are multiplied by t, output rises by t^1.1. Each exponent being below one only means diminishing marginal returns to each factor individually.
Question 6
The slope of an isoquant measures the:
- A) Marginal rate of substitution between two goods
- B) Ratio of factor prices
- C) Marginal rate of technical substitution between the factors
- D) Marginal cost of production
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Answer: C) Marginal rate of technical substitution between the factors
An isoquant shows combinations of two inputs that produce the same output. Its slope is the MRTS of labour for capital, equal to MPL/MPK. The ratio of factor prices is the slope of the isocost line; MRS between goods is the slope of an indifference curve.
Question 7
A firm uses labour and capital. MPL = 20 units, wage = Rs. 4, MPK = 30 units, rental of capital = Rs. 10. To minimise the cost of producing its current output, the firm should:
- A) Use more capital and less labour
- B) Make no change in the input mix
- C) Use more labour and less capital
- D) Reduce both inputs in the same proportion
Show answer & explanation
Answer: C) Use more labour and less capital
Least-cost combination requires MPL/w = MPK/r. MPL/w = 20/4 = 5 units per rupee; MPK/r = 30/10 = 3 units per rupee. A rupee spent on labour yields more output, so the firm should substitute labour for capital until the ratios are equal.
Question 8
Which of the following is a fixed cost for a firm in the short run?
- A) Cost of raw materials
- B) Power consumed by machines
- C) Rent paid for the factory building
- D) Wages of casual workers paid per unit of output
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Answer: C) Rent paid for the factory building
Fixed costs do not vary with output in the short run; rent on the factory must be paid even at zero output. Raw materials, power and piece-rate wages rise with output and are variable costs.
Question 9
A firm's total fixed cost is Rs. 600. At an output of 50 units, its total variable cost is Rs. 1,400. Its average total cost at this output is:
- A) Rs. 40
- B) Rs. 28
- C) Rs. 12
- D) Rs. 52
Show answer & explanation
Answer: A) Rs. 40
TC = TFC + TVC = 600 + 1,400 = Rs. 2,000. ATC = TC/Q = 2,000/50 = Rs. 40. Equivalently AFC = 600/50 = 12 and AVC = 1,400/50 = 28, so ATC = 12 + 28 = 40.
Question 10
Total cost of producing 10 units is Rs. 1,250 and of producing 11 units is Rs. 1,320. The marginal cost of the 11th unit is:
- A) Rs. 120
- B) Rs. 125
- C) Rs. 70
- D) Rs. 1,320
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Answer: C) Rs. 70
MC of the nth unit = TCn - TCn-1 = 1,320 - 1,250 = Rs. 70. Rs. 120 is the average cost at 11 units (1,320/11) and Rs. 125 is the average cost at 10 units.
Question 11
Which statement about the relationship between marginal cost (MC) and average cost (AC) is correct?
- A) MC cuts AVC at its minimum but ATC at its maximum
- B) MC cuts both AVC and ATC at their respective minimum points from below
- C) MC is always below ATC
- D) MC and ATC reach their minimum at the same output
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Answer: B) MC cuts both AVC and ATC at their respective minimum points from below
When MC is below an average, the average falls; when MC is above it, the average rises. Therefore MC intersects AVC and ATC at their minimum points, rising through them from below. Because ATC includes AFC, its minimum occurs at a larger output than the minimum of AVC and MC.
Question 12
The long-run average cost curve is called an 'envelope curve' because:
- A) It always lies above all short-run average cost curves
- B) It is tangent to a series of short-run average cost curves, each representing a different plant size
- C) It passes through the minimum point of every short-run average cost curve
- D) It is the sum of all short-run average cost curves
Show answer & explanation
Answer: B) It is tangent to a series of short-run average cost curves, each representing a different plant size
The LAC shows the least cost of producing each output when all inputs, including plant size, can be varied. It envelops the SAC curves by being tangent to each of them. It touches the minimum point of only the SAC that is tangent at the LAC's own minimum (the optimum plant).
Question 13
A firm's short-run total cost function is TC = 500 + 20Q + Q^2. At Q = 10, average variable cost and marginal cost respectively are:
- A) Rs. 80 and Rs. 40
- B) Rs. 30 and Rs. 30
- C) Rs. 50 and Rs. 40
- D) Rs. 30 and Rs. 40
Show answer & explanation
Answer: D) Rs. 30 and Rs. 40
TFC = 500, TVC = 20Q + Q^2. At Q = 10, TVC = 200 + 100 = 300, so AVC = 300/10 = Rs. 30. MC = dTC/dQ = 20 + 2Q = 20 + 20 = Rs. 40. Rs. 80 is ATC (TC = 800, 800/10), and Rs. 50 is AFC (500/10).
Question 14
Savings arising from the use of larger and more specialised machinery as a firm expands its scale are an example of:
- A) Internal technical economies of scale
- B) External economies of scale
- C) Diseconomies of scale
- D) Economies of scope
Show answer & explanation
Answer: A) Internal technical economies of scale
Internal economies arise within the firm as it grows; technical economies stem from indivisible, specialised and larger machines that lower cost per unit. External economies accrue to all firms from the growth of the industry, and economies of scope come from producing several products together.
Question 15
A firm's total revenue for the year is Rs. 11,00,000 and its explicit (accounting) costs are Rs. 8,00,000. The owner's implicit costs, including normal profit, are Rs. 2,00,000. Which statement is correct?
- A) Accounting profit is Rs. 3,00,000 and economic profit is Rs. 1,00,000
- B) Accounting profit is Rs. 1,00,000 and economic profit is Rs. 3,00,000
- C) Accounting and economic profit are both Rs. 3,00,000
- D) Accounting profit is Rs. 3,00,000 and the firm earns only normal profit
Show answer & explanation
Answer: A) Accounting profit is Rs. 3,00,000 and economic profit is Rs. 1,00,000
Accounting profit = revenue - explicit costs = 11,00,000 - 8,00,000 = Rs. 3,00,000. Economic profit = revenue - (explicit + implicit costs) = 11,00,000 - 10,00,000 = Rs. 1,00,000. Since economic profit is positive, the firm earns supernormal profit, not merely normal profit.