Question Bank

(Module – IV)

 

SECTION A: Very Short Answer Questions

 

Define production in economics.
Production is the process of converting raw materials or inputs like land, labor, and capital into useful goods and services that satisfy human wants. It is the creation of utility through the transformation of resources.

1. List the four factors of production.
   The four basic factors of production are:
   (i) Land – natural resources,
   (ii) Labor – human effort,
   (iii) Capital – tools, machines, and buildings,
   (iv) Entrepreneurship – innovation and risk-taking ability of the entrepreneur.*

 

2. What is meant by the law of variable proportions?
   It refers to the change in output when one input is increased while others are kept fixed. Initially, output increases rapidly, then at a diminishing rate, and finally may decline. It applies in the short run.

 

3. Define returns to scale.
   Returns to scale show the change in output when all inputs are increased in the same proportion. If output increases more than inputs, it's increasing returns; if equal, constant; and if less, decreasing returns.

 

4. Distinguish between internal and external economies of scale.
   Internal economies are cost savings within a firm due to its own expansion (e.g., better machines), while external economies occur outside the firm but within the industry (e.g., skilled labor due to cluster of firms).

 

5. What is accounting cost?
   It is the actual out-of-pocket expenditure made by a firm. It includes payments for raw materials, wages, rent, electricity, etc., and is recorded in the books of accounts.

 

6. Define sunk cost with an example.
   Sunk cost is a past expense that cannot be recovered, such as money spent on a marketing campaign last year. These costs should not affect future business decisions.

 

7. What is marginal cost?
   Marginal cost is the additional cost incurred to produce one more unit of output. It is calculated as the change in total cost divided by the change in output.

 

8. What is opportunity cost? Give an example.
   Opportunity cost is the cost of the next best alternative foregone when a choice is made. For example, if you choose to start a business instead of taking a job, the salary of that job is your opportunity cost.
9. Define depreciation.
   Depreciation is the reduction in the value of a fixed asset over time due to wear and tear, age, or obsolescence. It helps determine the true value of assets and profits.

 

SECTION B: Short Answer Questions

 

1. Explain the role of each factor of production.

Each factor plays a vital role in production. Land provides space and natural resources like minerals and water. Labor refers to human effort – both physical (like construction workers) and mental (like engineers). Capital includes man-made tools like machines, buildings, and technology that help increase productivity. Entrepreneurship is the ability to organize land, labor, and capital to produce goods efficiently. Entrepreneurs also bear risk and make decisions to innovate and compete in the market. Together, these four factors make production possible and efficient.

 

2. Describe the three stages of the law of variable proportions.
   The law describes how output changes when one input (say labor) increases while others remain fixed.
• Stage I: Increasing returns – Each additional unit of input gives more output due to better utilization of fixed inputs.
• Stage II: Diminishing returns – Output continues to increase, but at a decreasing rate. Fixed inputs become a limiting factor.
• Stage III: Negative returns – Additional input causes total output to fall, due to overcrowding or inefficiency.
  Firms aim to operate in Stage II where efficiency is optimal.

 

3. Differentiate between economies and diseconomies of scale.
   As firms grow, they may enjoy economies of scale – cost advantages from large-scale production. Examples: buying in bulk, using advanced machinery, specialization of labor. However, beyond a point, diseconomies of scale can arise, like difficulty in managing operations, communication issues, and loss of employee motivation. These lead to higher per-unit costs. Economies reduce average costs; diseconomies increase them.

 

4. Explain the difference between fixed and variable costs.
   Fixed costs remain the same regardless of the output level – like rent, salaries of permanent staff, or insurance. Variable costs change with the level of production – like raw materials, electricity, and wages for temporary labor.

Total cost = fixed cost + variable cost.

Understanding the behavior of both types helps in budgeting and cost control.

 

5. Describe marginal cost and its relevance.

 

Marginal cost is the cost of producing one extra unit of output. It is calculated as:

MC = Change in Total Cost / Change in Output.

It helps firms decide the level of production. If MC is less than the price of the product, producing more is profitable. When MC equals price, profit is maximized. Hence, marginal cost is key in decision-making.

 

6. Explain break-even analysis with a simple illustration.
   Break-even analysis helps determine the output level at which total revenue equals total cost – no profit, no loss.
   Formula: Break-even point = Fixed Costs / (Selling Price – Variable Cost per unit).
   Example: Fixed cost = ₹20,000, selling price = ₹100/unit, variable cost = ₹60/unit.

BEP = 20,000 / (100 – 60) = 500 units.

It shows that 500 units must be sold to cover all costs. Above this point, the firm earns profit.

 

7. How is depreciation relevant to industry?
   
   

Depreciation accounts for the loss in value of assets like machinery, vehicles, and equipment over time. It affects financial reporting, tax liability, and investment planning. Industries need to plan for asset replacement by calculating depreciation. For example, a machine bought for ₹5,00,000 with a life of 10 years and no resale value would depreciate at ₹50,000 per year. This amount is deducted annually to show true profit and to save for new investments.