Question

9. What is the concept of cost of capital from the point of view of economists' definition of normal rate of return (same thing as interest rate on capital) on fixed investment (considered as fixed cost or sunk cost)? Give an example from SR production and cost function.

Answer 1

The normal rate of return that must be paid on an investor to induce investment in the business. The normal rate of return is also called the opportunity cost of capital. The opportunity cost of capital is the incremental return on investment that a business foregoes when it chooses for use assets for an internal project, as opposed to putting money in a marketable security. Therefore, if the projected return for the internal project is not exactly the expected rate of return for marketable security, one would not put resources into the interior undertaking, accepting this is the main reason for the choice. The opportunity cost of capital is the distinction between the return on the two projects.

Total fixed cost is the opportunity cost acquired in the short-run production that does not rely upon the quantity of output. As the name infers, the total fixed cost is fixed. A firm can produce a little output or a ton, increase or decrease production, or even quit creating through and through, however, the fixed cost stays unaltered. The fixed cost must be paid up to a firm is good to go in the short run. The best way to dodge fixed cost is to escape the business, which includes selling off all capital, and hence making the amount of fixed inputs of info drop to zero (no capital, no business). Be that as it may, in this manner, the firm is never again working in the short run since all inputs have gotten variable.