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Syed Ubaid Ahmed

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Contents
Q.NO.1........................................................................................................................................................... 3
Utility ......................................................................................................................................................... 3
Cardinal Utility Vs Ordinal Utility .............................................................................................................. 3
LAW OF DIMINISHING MARGINAL UTILITY ............................................................................................... 3
Relationship with the Law of Demand ...................................................................................................... 4
Q.NO.2........................................................................................................................................................... 5
INDIFFERENCE CURVES ............................................................................................................................. 5
PROPERTIES OF INDIFFERENCE CURVES ................................................................................................... 5
EXPLANATION OF CONVEXITY ................................................................................................................... 5
Q.NO. 3 .CONSUMERS EQUILIBRIUM ........................................................................................................... 6
Equilibrium ................................................................................................................................................ 6
Consumers Equilibrium ............................................................................................................................ 6
Condition: .................................................................................................................................................. 6
WHY DOES A CONSUMER CHOOSE WHERE MRS=CPR .......................................................................... 7
Q.NO.4........................................................................................................................................................... 8
A. VARIABLE INPUTS VS FIXED INPUTS ..................................................................................................... 8
Fixed Input ................................................................................................................................................ 8
Variable Input............................................................................................................................................ 8
B. SHORT VS LONG RUN ............................................................................................................................ 8
RELATION TO OF LAW OF PRODUCTION .................................................................................................. 8
Q.NO.5........................................................................................................................................................... 9
LAW OF DIMINISHING MARGINAL RETURNS: ........................................................................................... 9
CONDITION ............................................................................................................................................... 9
THREE STAGES ........................................................................................................................................... 9
Q.NO.6......................................................................................................................................................... 11
OPPORTUNITY COST ............................................................................................................................... 11
FIXED VS VARIABLE COSTS AS COMPONENTS OF TOTAL COST .............................................................. 11
MARGINAL AND AVERAGE COSTS ........................................................................................................... 11
LINK B/W PRODUCTION AND COST ........................................................................................................ 11
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ECONOMIES OF SCALE ............................................................................................................................ 12
RELATIONSHIP TO AVERAGE AND MARGINAL COSTS ............................................................................. 12
Q.NO.7......................................................................................................................................................... 13
(1) Increasing Returns to Scale: .............................................................................................................. 13
(2) Constant Returns to Scale: ................................................................................................................ 13
(3) Diminishing Returns to Scale: ........................................................................................................... 13
Graph/Diagram: .................................................................................................................................. 13
ECONOMIC REGION AND ECONOMIC REGION FOR TWO INPUTS ......................................................... 14
Q.NO.8......................................................................................................................................................... 15
CONCEPT OF ISOQUANT CURVES AND ISOCOST LINES .......................................................................... 15
ISOQUANT CURVES ................................................................................................................................. 15
ISOCOST LINES ........................................................................................................................................ 15
L-SHAPRED AND LINEAR ISOQUANT ....................................................................................................... 16
ILLUSTRATION OF OPTIMUM COMBINATION OF INPUTS ...................................................................... 17
Q.NO.9......................................................................................................................................................... 18
AVERAGE FIXED COST ............................................................................................................................. 18
AVERAGE VARIABLE COST ....................................................................................................................... 18
AVERAGE TOTAL COST ............................................................................................................................ 18
MARGINAL COST ..................................................................................................................................... 18
RELATIONSHIPS ....................................................................................................................................... 18
Q.NO.10 ...................................................................................................................................................... 21
Q.no.11........................................................................................................................................................ 24
FIND THE OUTPUT AT WHICH AVERAGE COST IS AT MINIMUM ............................................................ 24
Q.NO.12 ...................................................................................................................................................... 25
ECONOMIES AND DISECONOMIES OF SCALE .......................................................................................... 27
Q.NO.13: PRODUCTION FUNCTION AND PRODUCTION ANALYSIS ............................................................. 29
Q.NO.14 ...................................................................................................................................................... 31
UNDER WHAT CONDITIONS DOES MRTS DECREASES ............................................................................ 31
WHAT IS THE RATE OF CHANGE WHEN TWO INPUTS ARE PERFECET SUBSITUTES ................................ 32
Q.NO.15 ...................................................................................................................................................... 33

Syed Ubaid Ahmed

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Q.NO.1

Utility is usefulness, the ability of something to satisfy needs or wants
In economics, utility is a representation of preferences over some set of goods and services
Cardinal Utility Vs Ordinal Utility

Basis of Difference Cardinal Utility Ordinal Utility
Valuation of satisfaction According to the cardinal utility, the
satisfaction derived from the
consumption of a particular good
and service can be measured in
absolute numbers.
According to the ordinal utility, the
satisfaction derived from the
consumption of a particular good
and service cannot be measured in
absolute numbers.
Measurement of satisfaction Cardinal utility measures
satisfaction in terms of utils.
Ordinal utility measures satisfaction
in terms of ranks.
Measuring order Under cardinal utility, the
consumption of goods and services
providing higher satisfaction are
accorded higher utils.
Under ordinal utility, the
consumption of goods and services
providing higher satisfaction are
accorded higher ranks. That is the
consumption providing highest
satisfaction is accorded first rank.
Example For example, utility derived from
the consumption of a glass of milk is
3 utils.
For example, a glass of milk is
ranked 1
st
while a glass of soda is
ranked 2
nd
.


LAW OF DIMINISHING MARGINAL UTILITY

"Other things remaining the same when a person takes successive units of a commodity, the marginal
utility diminishes constantly".
The marginal utility of a commodity diminishes at the consumer gets larger quantities of it. Marginal
utility is the change in the total utility resulting from one unit change in the consumption of a
commodity per unit of time.
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OR
A principle stating that as the quantity of a good consumed increases, eventually each additional unit of
the good provides less additional utility--that is, marginal utility decreases. Each subsequent unit of a
good is valued less than the previous one. The law of diminishing marginal utility helps to explain the
negative slope of the demand curve and the law of demand.
The law of diminishing marginal utility means that the value of a good, the extra utility derived from a
good, declines as more of the good is consumed. This has a direct bearing on the market demand,
the demand price, and the law of demand. If the satisfaction obtained from a good declines, then buyers
are willing to pay a lower price, hence demand price is inversely related to quantity demanded, which is
the law of demand.

Relationship with the Law of Demand

While the law of diminishing marginal utility pops up throughout the study of economics, it is most
important to the study of demand and the law of demand. It offers preliminary insight into the age-old
question: "Why does the demand curve have a negative slope?"
The key to this connection is that the demand price that a buyer is willing and able to pay for a good
depends on the satisfaction (utility) generated from consumption. A buyer is willing to pay a higher
demand price if utility is greater or a lower demand price if utility is less. Because marginal utility
diminishes as the quantity of a good is consumed increases (the law of diminishing marginal utility),
buyers are willing and able to pay lower prices for larger quantities (the law of demand). Hence, the law
of demand exists because the less satisfaction is received for larger quantities.
This law of diminishing marginal utility is the counterpart of the law of diminishing marginal returns. As
the law of diminishing marginal utility offers an explanation for the law of demand and the negative
slope of the demand curve, the law of diminishing marginal returns offers an explanation for the law of
supply and the positive slope of the supply curve.

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Q.NO.2
INDIFFERENCE CURVES

An indifference curve shows all combinations of two goods which yield the same level of utility or
satisfaction to the consumer.

PROPERTIES OF INDIFFERENCE CURVES
The main attributes or properties or characteristics of indifference curves are as follows:
1. Indifference curves are negatively sloped. The indifference curves must slope down from left to right.
This means that an indifference curve is negatively sloped. It slopes downward because as the
consumer increases the consumption of X commodity, he has to give up certain units of Y commodity in
order to maintain the same level of satisfaction.
2. levels of satisfaction. A higher indifference curve that lies above and to the right of another
indifference curve represents a higher level of satisfaction and combination on a lower indifference
curve yields a lower satisfaction.
In other words we can say that the combination of goods which lies on a higher indifference curve
contains all along its length larger quantity of goods than the lower one.
3. Indifference curves are convex to the origin. This is an important property of indifference curves.
They are convex to the origin (bowed inward). This is equivalent to saying that as the consUmer
substitutes commodity X for commodity Y, the marginal rate of substitution diminishes of good X for
good Y along anindifference curve.
4. They do not intersect one another.
EXPLANATION OF CONVEXITY

At any point is the slope of a tangent line at that point.
An indifference curve is convex, meaning that the slope
decreases as you go down it.







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Q.NO. 3 .CONSUMERS EQUILIBRIUM

Equilibrium is a point when there is no tendency for change.

Consumers Equilibrium is a point where consumer is satisfied with all of his
consumptions

Condition:
Consumer will be in equilibrium only if Marginal utility per rupee spent is equal across all
consumptions

Or
When (Purple) Budget line is tangent to highest possible ID curve. i.e at Point A in the below
figure.
















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WHY DOES A CONSUMER CHOOSE WHERE MRS=CPR

A consumer chooses this point, because at this point Consumer maximizes his utility, as shown in
figure below.





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Q.NO.4

A. VARIABLE INPUTS VS FIXED INPUTS
Fixed Input: An input whose quantity a manager cannot change during a given period of Time.
Variable Input: An input whose quantity a manager can change during a given period of Time.
B. SHORT VS LONG RUN








Short Run : A production process that uses at least one fixed input
Long Run: A production process in which all inputs are Variable.
RELATION TO OF LAW OF PRODUCTION
When more and more of variable input(e.g. Labour) is applied to a fixed input (e.g. Machines), the total
production might increase at first at an increasing rate, then at a decreasing rate and then after reaching
at its maximum level it starts declining.
For Example:
Labour Machines Productivity MP
1 1 1 Unit 1
2 1 4 Unit 3
3 1 6 Unit 2
4 1 7 Unit 1


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Q.NO.5
LAW OF DIMINISHING MARGINAL RETURNS:
A principle of short-run production stating that as a firm combines more
of a variable input with a fixed input, the marginal product of the variable
input eventually declines. This is THE economic principle underlying the
analysis of short-run production for a firm. It offers an explanation for the
law of supply and the positive slope of the market supply curve.

CONDITION

THREE STAGES
Stage I
1) This stage starts from origin and
ends where AP & MP curves
intersect each other.
2) The TP is increasing at
increasing rate at first then at
decreasing rate.
3) PP and MP both increase but
MP is greater than IP.

Stage II
1) It starts where PP & MP
intersect each other. It ends when
MP = 0
2) TP increases but at decreasing
rate.
3) MP Starts to decline
continuously and AP also start to
decline but it is greater than MP

Stage III
1) This stage starts when MP is
zero and TP is at maximum.
2) TP starts to decline and it declines continuously.
3) MP becomes negative, remains positive.

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Labour TP MP AP
1 5 5 5.00
2 11 6 5.50
3 18 7 6.00
4 26 8 6.50
5 35 9 7.00
6 45 10 7.50
7 55 10 7.86
8 64 9 8.00
9 70 6 7.78
10 75 5 7.50
11 72 -3 6.55
12 76 4 6.33



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Q.NO.6
OPPORTUNITY COST

The opportunity cost of any alternative is defined as the cost of not selecting the "next-best" alternative.
Example: Suppose that you own a building that is worth $100,000 today and is expected to be worth
$100,000 one year from today. If the interest rate is 10%, what is the opportunity cost of using this
building for one year?

FIXED VS VARIABLE COSTS AS COMPONENTS OF TOTAL COST
Total Fixed Costs (TFC): costs of inputs that are fixed in the SR & do not change as the output level
changes.
Total Variable Costs (TVC): costs of inputs that are variable in the Short Run, and change as output level
changes, i.e., TVC = P
X
X
Total Costs (TC): TFC + TVC

MARGINAL AND AVERAGE COSTS
Average Costs
Average costs can be determined by dividing the firms costs by the quantity of output it produces.
The average cost is the cost of each typical unit of product.

Marginal Cost
Marginal cost (MC) measures the increase in total cost that arises from an extra unit of production.
Marginal cost helps answer the following question: How much does it cost to produce an additional unit
of output?
LINK B/W PRODUCTION AND COST
To produce more output in the short run, a firm employs more labor, which means it must increase its
costs. We describe the relationship between output and cost using three cost concepts:

Total cost
Marginal cost
Average cost

Total fixed cost (TFC) is constantit graphs as a horizontal
line.
Total variable cost (TVC) increases as output increases.
Total cost (TC) also increases as output increases.

The vertical distance between the total cost curve and the
total variable cost curve is total fixed cost, as illustrated by
the two arrows.
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ECONOMIES OF SCALE
Economies of scale exist if when a firm increases its plant size and labor employed by the same
percentage, its output increases by a larger percentage and average total cost decreases.

RELATIONSHIP TO AVERAGE AND MARGINAL COSTS











When average cost declines as output increases, this means that marginal cost must be below average
cost over that same period and the firm is exhibiting economies of scale. Conversely, when marginal cost
reaches a greater than average cost the firm is displaying diseconomies of scale. Generally, average
costs decline at low output levels and costs are increase at high levels of output. This creates a U-shaped
average cost curve with price per unit on the y-axis and quantity on the x-axis. A U-shape average cost
curve typically depicts a firms costs in the short run, because capacity constraints can increase costs.

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Q.NO.7
(1) Increasing Returns to Scale:

If the output of a firm increases more than in proportion to an equal percentage increase in all inputs,
the production is said to exhibit increasing returns to scale. For example, if the amount of inputs are
doubled and the output increases by more than double, it is said to be an increasing returns returns to
scale. When there is an increase in the scale of production, it leads to lower average cost per unit
produced as the firm enjoys economies of scale.
(2) Constant Returns to Scale:

When all inputs are increased by a certain percentage, the output increases by the same percentage, the
production function is said to exhibit constant returns to scale. For example, if a firm doubles inputs, it
doubles output. In case, it triples output. The constant scale of production has no effect on average cost
per unit produced.
(3) Diminishing Returns to Scale:

The term 'diminishing' returns to scale refers to scale where output increases in a smaller proportion
than the increase in all inputs. For example, if a firm increases inputs by 100% but the output decreases
by less than 100%, the firm is said to exhibit decreasing returns to scale. In case of decreasing returns to
scale, the firm faces diseconomies of scale. The firm's scale of production leads to higher average cost
per unit produced.
Graph/Diagram:
The figure 11.6 shows that when a firm uses one unit of labor and one unit of capital, point a, it
produces 1 unit of quantity as is shown on the q = 1 isoquant. When the firm doubles its outputs by
using 2 units of labor and 2 units of capital, it produces more than double from q = 1 to q = 3.
So the production function has
increasing returns to scale in this
range. Another output from quantity
3 to quantity 6. At the last doubling
point c to point d, the production
function has decreasing returns to
scale. The doubling of output from 4
units of input causes output to
increase from 6 to 8 units increases of
two units only.

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ECONOMIC REGION FOR TWO INPUTS




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Q.NO.8
CONCEPT OF ISOQUANT CURVES AND ISOCOST LINES
ISOQUANT CURVES
An isoquant curve is the locus of various combinations of inputs (K and L) which gives the same level of
output.
The concept of isoquant or equal product curve can be
better explained with the help of schedule given
below:
Combinations Factor X Factor Y Total Output
A 1 14 100 METERS
B 2 10 100 METERS
C 3 7 100 METERS
D 4 5 100 METERS
E 5 4 100 METERS

There are five combinations which produce the same
level of output (100 meters of cloth).
Properties of Isoquant:
They have a negative slope
They are convex to the origion
They do not cross/intersect eachother
Higher isoquant curves represents higher scale of production

ISOCOST LINES
An isocost is a graph that shows all
the combinations of capital and
labour available for a given cost.

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L-SHAPRED AND LINEAR ISOQUANT

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ILLUSTRATION OF OPTIMUM COMBINATION OF INPUTS
Combination of inputs is optimized at a point (P) when Iso-cost line is tangent to the highest possible
cost curve.




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Q.NO.9

AVERAGE FIXED COST is the fixed cost per unit of output. AFC = FC/Q

AVERAGE VARIABLE COST is the variable cost per unit of output. AVC = VC/Q

AVERAGE TOTAL COST, often referred to simply as average cost, is total cost divided by quantity
of output produced. ATC = TC/Q
MARGINAL COST


RELATIONSHIPS
At the minimum-cost output,
average total cost is equal to
marginal cost.
At output less than the
minimum-cost output, marginal
cost is less than average total
cost and average total cost is
falling.
And at output greater than the
minimum-cost output, marginal
cost is greater than average total
cost and average total cost is
rising.



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OR
When marginal cost is below
average (total or variable) cost,
average cost will decline.
When marginal cost is above
average cost, average cost rises.
When average cost is at a minimum,
marginal cost is equal to average
cost.





Marginal cost curves do
not always slope upward.
The benefits of
specialization of labor can
lead to increasing returns
at first represented by a
downward-sloping
marginal cost curve. Once
there are enough workers
to permit specialization,
however, diminishing
returns set in.




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OR
The ACs reaches a minimum when the slope of the ray from the origin to the total cost curve is
tangent.
AVC is the slope of a ray from the origin to the total variable cost function.
When the slope of the ray from the origin to the V(q) curve is tangent, AVC is at a minimum.
The difference between AC and AVC decreases as the quantity increases because AFC=F/q
decreases.






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Q.NO.10

Isocost curve: The set of
combinations of inputs that cost the
same amount








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Q.no.11
TC = 128 + 169Q 14Q
2
+Q
3
AC = 128/Q + 169 14Q + Q
2
MC = 169 28Q +3Q
2

AVC = 169 14Q + Q
2
FIND THE OUTPUT AT WHICH AVERAGE COST IS AT MINIMUM
We know that Avg.Cost is minimized when AC = MC
AC = 128/Q + 169 14Q + Q
2
MC = 169 28Q +3Q
2

128/Q + 169 14Q + Q
2
=

169 28Q +3Q
2
128/Q = 2Q
2
14Q

128 = 2Q
3
- 14 Q
2
Divide the whole equation by 2
64 = Q
3
- 7Q
2

64 = Q
2
(Q 7)
Either Q
2
= 64 or Q-7= 64
Q
2
= 64 or Q = 64 7
Q
2
= 8
2
or Q = 57
Q = 8; Q= - 8
Avg.Cost will be minimum at Q=8. (Other values of Q does not represent rational output level, thus are
negligible)

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Q.NO.12








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ECONOMIES AND DISECONOMIES OF SCALE
There are economies of scale when long-run average total cost declines as output increases.
There are diseconomies of scale when long-run average total cost increases as output increases.










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MINIMUM EFFICIENT SIZE OF A FIRM..(Cont..)
A firms minimum efficient scale (MES) is the lowest scale necessary to achieve the economies of
scale required to operate efficiently and competitively in its industry. No further significant
economies of scale can be achieved beyond this scale.
Minimum efficient scale affects the number of firms that can operate in a
market, and the structure of markets.



Relationship of Size of Minimum Efficient Scale to average cost and marginal cost
The minimum efficient scale can be computed by equating average cost (AC) with marginal cost (MC). The
rationale behind this is that if a firm were to produce a small number of units, its average cost per unit would be
high because the bulk of the costs would come from fixed costs. But if the firm produces more units, the average
cost incurred per unit will be lower as the fixed costs are spread over a larger number of units; the marginal cost is
below the average cost, pulling the latter down. The efficient scale of production is then reached when the average
cost is at its minimum and therefore the same as the marginal cost.

PERFECT COMPETITION AND MINIMUM EFFICIENT SIZE (MES) OF A FIRM
If the minimum efficient scale (MES) is small relative to the overall size of the market (demand for the good), there
will be a large number of firms. The firms in this market will be likely to behave in a perfectly competitive manner
due to the large number of competitors. For example MES = 10 units and Market demand is 1,000 units. This
means 100 firms can exist at the same time to satisfy the overall market demand.
OLIGOPOLY AND MINIMUM EFFICIENT SIZE OF A FIRM
If minimum efficient scale can only be achieved at high levels of output relative to the overall size of the market
(demand for the good), the number of firms in the industry will be small. For example MES = 10 units and Market
demand is 500 units. This means 5 firms can exist at the same time to satisfy the overall market demand. This is
the case of oligopoly.
MONOPOLY AND MINIMUM EFFICIENT SIZE OF A FIRM
If minimum efficient scale can only be achieved at very high levels of output relative to the whole industry, the
number of firms in the industry will be small or equal to 1. For example MES = 10 units and Market demand is 15
units. This means only 1 firm is there to satisfy the overall market demand. This is case with natural monopolies,
such as water, gas, and electricity supply.


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Q.NO.13: PRODUCTION FUNCTION AND PRODUCTION ANALYSIS








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Q = 10L + 5L
2
L
3
MP = 10 + 10L 3L
2

AP = 10 + 5L L
2
Q = 10L + 5L
2
L
3
When L= 5,
TP = 50 + (5 x 25) (125)
TP = 5
MP = 10 + 10L 3L
2

When L= 5,
MP = 10 + (10 x 5) ( 3 x 5
2
)
MP = 10 + 50 75
MP = - 15
AP = 10 + 5L L
2
When L= 5,
AP = 10 +50-25
AP = 35

TP is maximized when MP=0
10 + 10L 3L
2
= 0
3L
2
10L 10
=
0
Using quadratic formula, we get L= 4.138
L= 4
AP is maximized when MP=AP
10 + 10L 3L
2
= 10 + 5L L
2

2L
2
5L = 0
L (2L-5) = 0
2L-5 = 0
L = 5/2


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Q.NO.14





UNDER WHAT CONDITIONS DOES MRTS DECREASES

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WHAT IS THE RATE OF CHANGE WHEN TWO INPUTS ARE PERFECET
SUBSITUTES


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Q.NO.15
Part a. Envelope curve is long run AC curve. , For Derivation of LAC and LMC, See answer of Q.no.12
Relations b/w LAC and LMC


Part c: How can you find the minimum long run Average Cost Curve?
The point where LMC intersects LAC, LAC is at its minimum.

If someone finds some mistakes in the solutions please mail me @
ubaidahmed@outlok.com so that I could improve it and let others know.

Good Luck

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