Q.(a) Explain the different kinds of costs.

(a) Economists classify costs in several ways — explicit/implicit, fixed/variable, total/average/marginal, private/social, and opportunity cost. (b) A monopolistically competitive firm equates MR and MC; in the long run free entry reduces profit to normal, leaving it with excess (unused) capacity.

(a) Different kinds of costs

• Money cost vs real cost — money cost is the actual expenditure in money terms; real cost is the effort and sacrifice involved in production.
• Explicit cost vs implicit cost — explicit costs are actual payments made to outsiders (wages, rent, raw materials); implicit costs are the imputed value of the firm's own factors (owner's labour, own capital).
• Opportunity cost — the value of the next-best alternative foregone.
• Fixed cost (TFC) vs variable cost (TVC) — fixed costs do not change with output (rent, salaries); variable costs change with output (raw materials, power). Total Cost (TC) = TFC + TVC.
• Average cost (AC = TC/Q), Average Fixed Cost (AFC), Average Variable Cost (AVC) and Marginal Cost (MC) — per-unit and incremental measures.
• Short-run vs long-run costs — short run has fixed and variable costs; long run has only variable costs.
• Private cost vs social cost — private cost is borne by the producer; social cost includes external costs borne by society.
• Sunk cost — cost already incurred and not recoverable.

(b) Output determination under monopolistic competition

Monopolistic competition (Chamberlin) has many sellers, differentiated (close but not identical) products, free entry and exit, and selling/advertising costs. Because products are differentiated, each firm faces a downward-sloping but highly elastic demand (AR) curve, with MR below AR.

Equilibrium output is where MR = MC and MC cuts MR from below.

• Short run: the firm can earn supernormal profit (price/AR above AC), normal profit, or a loss (AR below AC), depending on demand. …