ECO402 Assignment No 2 Spring 2012 solution

The Case:
Sialkot is well known for the production and distribution of sports products. The market of sports works under monopolistic competition where each firm has to compete with several firms. These firms not only manufacture sports goods to meet domestic demand but also export to other countries. Consider a new firm, Ahmed Brothers, started its business of manufacturing sports goods in Sialkot. The owner of Ahmed Brothers had invested capital of amount Rs. 15, 00,000 to start this business. He also had the option to invest this capital in a bank at 10% rate of interest per annum but he preferred to start his own business. In the starting year, the firm employed 100 workers and paid total amount of Rs. 500,000 to these employees. The average salary of the employees was Rs. 5, 000. The firm incurred cost of Rs. 400, 000 in setting up its business including cost of plant and machinery. Further, the firm paid Rs. 400, 000 for raw material. The rent of building paid in this year was Rs. 180, 000 and the lump sum amount of tax for this year was Rs. 20,000. This firm produced total 9, 000 units in this year. The selling price of each unit was Rs. 200.

Requirements:

Part A:
From the information given above, calculate:
a. Fixed cost and variable cost of the firm.
b. Average cost of firm.
c. Accounting profit of the firm.
d. Economic profit of the firm.
Part B:
What production decision firm will take for future after calculating economic profit?
(Marks: Part A=8+4+5+5, Part B=3)

 Idea Solution:

A.

Fixed cost                   =          1100,000

 B.  

Variable cost              =          firm paid for raw material = 400,000

Average cost             =          166.67 per unit

c. Accounting profit of the firm.

Accounting profit of the firm= R-wL

R=revenue = 200*9,000=180,0000

wL= Labor cost =5,000

Accounting profit of the firm= R-wL

=180,0000-5,000

=1795000

 

d. Economic profit of the firm.

Economic profit of the firm= R-wL-rK

R=revenue = 200*9,000=180,0000

wL= Labor cost =5,000

wK = opportunity cost of capital = 15, 00,000*10%=15,0000

 

Economic profit of the firm= R-wL-rK

=180,000-5,000-15,0000

=25000

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