CHAPTER 8 1THE FIRM AND THE INDUSTRY UNDER PERFECT COMPETITION

TRUE-FALSE QUESTIONS
PERFECT COMPETITION DEFINED
1. 2. 3. 4. 5. 6. 7. Perfectcompetitionisanidealmarketstructure. ANSWERT,M,R Perfectlycompetitivemarketshaveabsolutelynodrawbacks. ANSWERF,M,R Perfectcompetitionformsoneextremeofthemarketstructurespectrum. ANSWERT,E,R Perfectcompetitionischaracterizedbynumerousfirms. ANSWERT,E,R Itisrelativelyeasyforafirmtoenteraperfectlycompetitivemarket. ANSWERT,M,R Perfectlycompetitivemarketsfeaturerelativelyhighbarrierstoentry. ANSWERF,E,R Underthetheoryofperfectcompetition,firmsandbuyersknowtheavailabilityandprices associatedwithallproductsinthemarket. ANSWERT,M,R Underperfectcompetition,firmsarerelativelyignorantoftheactionsoftheircompetitors. ANSWERF,E,R Inperfectcompetitiontherearedifferencesintheproductssoldbyvariousfirms. ANSWERF,M,R Inthelongrun,aperfectlycompetitiveindustrytendstodevelopdifferentiatedproducts. ANSWERF,D,R Perfectlycompetitivefirmsareknownforbeingpricemakers. ANSWERF,E,R

8. 9. 10. 11.

4 y Chapter 8/The Firm and the Industry Under Perfect Competition 12. 13. Themarketfortoothpasteisagoodexampleofperfectcompetition. ANSWERF,E,A Perfectlycompetitivemarketsarenotthebestatproducingthegoodsthataredesiredby consumers. ANSWERF,E,R Perfectlycompetitivemarketsarenotthemostefficienttype. ANSWERF,E,R

14.

THE COMPETITIVE FIRM

15. Aperfectlycompetitivefirmisapricetakerbecauseitcannotsellitsproductformore thanthemarketprice. ANSWERT,E,R Aperfectlycompetitivefirmisapricemaker. ANSWERF,M,R Aperfectlycompetitivefirmmay,undersomecircumstances,beabletoaffectthemarket price. ANSWERF,E,R Aperfectlycompetitivefirmhasahorizontaldemandcurvebecauseitcansellasmuchas itwantsatthemarketprice. ANSWERT,E,R Thedemandcurveofaperfectlycompetitivefirmisvertical. ANSWERF,E,R Inperfectcompetition,afirmsmarginalrevenueequalsthepriceoftheproduct. ANSWERT,D,A AperfectlycompetitivefirmwillnotoperatewhereMC=MRbutatMC=AC. ANSWERF,M,R AfirmoperatingatMC=MRmustbemakingaprofit. ANSWERF,E,A AperfectlycompetitivefirmcanmaximizeprofitsbyproducingthequantityatwhichMR exceedsMCbythegreatestamount. ANSWERF,M,A Intheshortrun,aperfectlycompetitivefirmcanmakeaprofit,aloss,orshutdown. ANSWERT,M,R

16. 17.

18.

19. 20. 21. 22. 23.

24.

Chapter 8/The Firm and the Industry Under Perfect Competition y 5 25. Intheshortrun,aperfectlycompetitivefirmcanmakeaprofit,aloss,orgooutof business. ANSWERF,M,R Onceafirmsmarginalrevenuecurveisknown,theoutputlevelcanbedetermined. ANSWERF,M,A Theshortrunequilibriumoutputofacompetitivefirmisfoundbyequatingmarginalcost withprice. ANSWERT,M,R Totalprofitofacompetitivefirmcanbefoundbymultiplyingprofitperunittimesunits sold. ANSWERT,E,A IfafirmsellsitsoutputatapricegreaterthanAC,itwillearneconomicprofit. ANSWERT,E,A IfafirmsellsitsoutputatapricegreaterthanAVC,itwillearneconomicprofit. ANSWERF,M,A Intheshortrun,afirmmayhaveaccountinglossesandremaininoperation. ANSWERT,M,A IfTR<TC,aperfectlycompetitivefirmwillalwaysshutdown. ANSWERF,M,A AslongasTVC<TR,afirmwillhaveapositivelevelofoutputintheshortrun. ANSWERT,E,A Usingonlymarginalrevenueandmarginalcost,wecandeterminewhetherafirmis incurringaprofitoraloss. ANSWERF,M,A Thelowestpricethatacompetitivefirmwillacceptwithoutclosingitsdoorsisfoundby examiningtheaveragevariablecostcurve. ANSWERT,M,A Itpaysthefirmtoproduceonlyiftotalvariablecostsexceedtotalrevenue. ANSWERF,D,A Intheshortrun,ifpriceisbelowAC,maximizingprofitsreallymeansminimizingtotal losses. ANSWERT,D,A TheshortrunsupplycurveforaperfectlycompetitivefirmisthatportionoftheMCcurve abovetheAVCcurve. ANSWERT,E,R

26. 27.

28.

29. 30. 31. 32. 33. 34.

35.

36. 37.

38.

6 y Chapter 8/The Firm and the Industry Under Perfect Competition 39. Theshortrunsupplycurvefortheperfectlycompetitivefirmisthatpartofthemarginal costcurvethatliesabovetheaveragefixedcostcurve. ANSWERF,M,A Aperfectlycompetitivefirmsshortrunsupplyisinfiniteatthemarketprice. ANSWERF,E,R

40.

THE COMPETITIVE INDUSTRY

41. Intheshortrun,onlyalimitednumberofnewfirmsmayenteraperfectlycompetitive market. ANSWERF,M,R Theshortrunmarketdemandscheduleinperfectcompetitionispositivelysloped. ANSWERF,E,R Themarketdemandscheduleinperfectcompetitionishorizontal. ANSWERF,E,R Theentryofnewfirmsintoaperfectlycompetitivemarketshiftsthedemandcurve outward. ANSWERF,M,A Zeroeconomicprofitmeansthatthefirmsownersreceivenocompensationfortheir investment. ANSWERF,M,R Theopportunitycostofagiveninvestmentisthepotentialearningsforfeitedbytyingup moneyintheinvestment. ANSWERT,E,A Economicprofitequalsgrossearningsminusthefirmsdirectcosts. ANSWERF,M,R Zeroprofitintheeconomicsensemeansthatfirmsareearninganormalrateofreturn. ANSWERT,M,R Afirmthatisearningzeroeconomicprofitshouldgooutofbusiness. ANSWERF,M,R Inalongrunequilibriuminaperfectlycompetitivemarket,theaveragefirmearns positiveeconomicprofits. ANSWERF,E,R Inalongrunequilibriuminaperfectlycompetitivemarket,firmsaresellingataprice equaltomarginalcost. ANSWERT,E,R

42. 43. 44.

45.

46.

47. 48. 49. 50.

51.

Chapter 8/The Firm and the Industry Under Perfect Competition y 7 52. Inalongrunequilibriuminaperfectlycompetitivemarket,firmsaresellingataprice equaltoaveragecost. ANSWERT,E,R Inthelongrun,aperfectlycompetitivefirmmaximizesprofitsoP=MC=AC. ANSWERT,E,R Inthelongrun,aperfectlycompetitivefirmearnsnoaccountingprofits. ANSWERF,E,A Inlongrunequilibrium,afirminperfectcompetitionhasnoeconomicprofit. ANSWERT,M,R Anindustrysupplycurveisthehorizontalsummationofthesupplycurvesofallofthe individualfirms. ANSWERT,E,A Inthelongrun,anyfirmmayenterorleaveaperfectlycompetitivemarket. ANSWERT,E,R Thenumberoffirmsinaperfectlycompetitiveindustryisnotfixedinthelongrun. ANSWERT,M,A Foraperfectlycompetitivefirm,thelongrunsupplycurveisthelongrunaveragecost curve. ANSWERT,M,A

53. 54. 55. 56.

57. 58. 59.

PERFECT COMPETITION AND ECONOMIC EFFICIENCY

60. Inlongrunequilibriuminperfectcompetition,everyfirmisproducingatminimum averagecost. ANSWERT,E,R Firmsinaperfectlycompetitivemarketproduceatminimumaveragecostintheshortrun andthelongrun. ANSWERF,M,A Subsidizingfirmsthatpollutewillreducepollutioninthelongrun. ANSWERF,E,R

61.

62.

8 y Chapter 8/The Firm and the Industry Under Perfect Competition

MULTIPLE-CHOICE QUESTIONS
PERFECT COMPETITION DEFINED
63. Amarket a. maybeanorganizedexchange. b. referstoasetofsellersandbuyerswhoseactionsaffectacommoditysprice. c. isthatareainwhichbuyersandsellerscompetetoeffectaproductprice. M,R d. Alloftheabovearecorrect. 64. Todeterminewhetheramarketisperfectlycompetitive,economistsexaminethe a. numberoffirmsinthemarket. b. similaritiesamongtheproductsofthedifferentfirmsinthemarket. c. easeofentryandexitbyfirmsinthemarket. E,R d. Alloftheabovearecorrect. 65. Thestrengthofthecompetitionfacedbyacompanycanprofoundlyaffectits a. pricing. b. outputdecisions. c. inputdecisions. M,A d. Alloftheabovearecorrect. 66. Whichofthefollowingisnotacharacteristicofperfectcompetition? a. Firmsandconsumersallhaveperfectinformationaboutthegoodandmarket. b. Sellerscanenterthemarketeasily. c. Allgoodssoldareidentical. E,R d. Allconsumershaveidenticalindividualdemandcurves. 67. Aperfectlycompetitivefirmisaprice a. giver. E,R b. taker. c. maker. d. leader. 68. Whichofthefollowingisacharacteristicofaperfectlycompetitivemarket? a. afewlargefirms b. firmsproducingspecializedproductsinordertoattractconsumers c. eachindividualfirmhavingsomecontroloverthemarketprice E,R d. alargenumberofsmallfirms 69. Oneofthefollowingisnotacharacteristicofperfectcompetition.Whichisit? M,R a. Firmsadvertisetoincreasetheirmarketshare. b. Profitsarelow. c. Consumerspaylittleattentiontobrandnames. d. Firmspaynoattentiontotheircompetitorsoutputlevels.

Chapter 8/The Firm and the Industry Under Perfect Competition y 9 70. Firmsinperfectcompetitionareoftendescribedasprice E,R a. takers. b. makers. c. setters. d. leaders. 71. Whichofthefollowingmostresemblesaperfectlycompetitivemarket? M,I a. thestockmarket b. thepublishingindustry c. thesteelindustry d. thenewcarmarket 72. E,I Perfectcompetitionisthetermusedtodescribe a. anindustryinwhichallbusinessmenarehonestandaccommodating. b. anindustryinwhichnumerousfirmsproduceidenticalproducts. c. anindustryuntouchedbygovernmentregulation. d. thekindofindustryanyAmericanwouldsupport.

73.

Economistsstudyperfectcompetition a. becausemanymarketsareperfectlycompetitive. b. foritsdescriptiverealism. M,R c. toestablishabenchmarkbywhichtomeasuretheperformanceoftheeconomy. d. Alloftheabovearecorrect. 74. Whichofthefollowingisclosesttotheeconomistsdefinitionofperfectcompetition? a. theairlineindustry b. thesoftdrinkindustry c. thefishingindustry d. thelongdistancetelephoneservice

E,I

10 y Chapter 8/The Firm and the Industry Under Perfect Competition 75. Theresultthatperfectlycompetitivefirmsproduceatthelowestperunitcostisderived fromtheassumptionsof a. homogeneousproducts. b. fewsellers. c. firmsfacinghorizontaldemandcurves. D,I d. freeentryandexit.

THE COMPETITIVE FIRM

76. Inamarketwithperfectlycompetitivefirms,themarketdemandcurveisusually______ andthedemandcurvefacingeachindividualfirm______. a. upwardsloping;horizontal M,R b. downwardsloping;horizontal c. horizontal;downwardsloping d. downwardsloping;downwardsloping 77. Afirmfacingahorizontaldemandcurve a. cannotaffectthepriceitreceivesforitsoutput. b. alwaysproducesatanoutputatwhichP=MR. c. facesperfectlyelasticdemandforitsproduct. d. Alloftheabovearecorrect.

E,I 78.

Foraperfectlycompetitivefirm,marginalrevenueequalsaveragerevenuebecausethe a. firmssupplycurveishorizontal. b. industrysdemandcurveishorizontal D,A c. firmsdemandcurveishorizontal. d. industryssupplycurveishorizontal. 79. Inaperfectlycompetitiveindustry,influenceoverpriceisexertedby a. individualsellers. b. individualbuyers. c. thelargestfirms. M,R d. theforcesofsupplyanddemand. 80. Thecompetitivefirmhasnoinfluenceoverpricebecause M,A a. itsoutputissoinsignificantrelativetothemarketasawhole. b. antitrustlawsconstrainperfectlycompetitivefirms. c. consumersestablishthepricesofproducts. d. itdoesntknowitsdemandcurve.

Chapter 8/The Firm and the Industry Under Perfect Competition y 11 81. Ataperfectlycompetitivefirmsshortrunequilibriumlevelofoutput, M,R a. P=MR=MC. b. P=MR,butMRdoesnotequalMC. c. P=MC,butMRdoesnotequalMC. d. MR=MCandP<MR. 82. Inshortrunequilibrium,aperfectlycompetitivefirm E,R a. mayearnaprofitoraloss. b. alwaysearnsaprofit. c. neverearnsaprofit. d. earnsaprofitonlyifthefirmhasnofixedcost. 83. Afirminshortrunequilibriumalwaysearnspositiveprofitsif a. SRAC>P>SRAVC. M,I b. SRAR>SRAC. c. MR=MC. d. SRAC>MC.

FIGURE 8-1

84.

IftheprofitmaximizingfirmdepictedinFigure81isperfectlycompetitive,howmuch outputshoulditproduce? a. A b. B E,A c. C d. D

12 y Chapter 8/The Firm and the Industry Under Perfect Competition 85. Afirmearnsaprofitofexactlyzeroatitsoptimaloutputlevelonlyif a. P=MR. b. P=MC. M,A c. P=AC. d. P=SRAVC. TABLE 8-1 Q(inunits)AFC(indollars) AVC(indollars) MC(indollars) 0 C C C 2 2.5 18 10 4 1.25 14 14 6 0.83 18 42 8 0.63 30 94 10 0.5 50 170

86.

InTable81aretheshortruncostschedulesofaperfectlycompetitivefirm.Ifthemarket priceofoutputis$50,thefirmwillproduce______unitsandearnaprofitof______. D,I a. 6;$187.02 b. 6;$48 c. 8;$154.96 d. 8;$245.04

FIGURE 8-2

Chapter 8/The Firm and the Industry Under Perfect Competition y 13 87. Figure82showsdemandandshortruncostcurvesforaperfectlycompetitivefirm.Atits profitmaximizinglevelofoutput,thefirmsshortrunTCisrepresentedbyarea M,I a. ADFO. b. BGHC. c. BGIO. d. ADGIO. 88. Figure82showsdemandandshortruncostcurvesforaperfectlycompetitivefirm.Atits profitmaximizingoutput,thefirmstotal______isrepresentedbyarea______. a. loss;GBHC b. profit;ADGHC D,I c. loss;ADEC d. profit;EGH 89. Figure82showsdemandandshortruncostcurvesforaperfectlycompetitivefirm.Inthe shortrun,thisfirmwould a. earnpositiveeconomicprofits. M,I b. earneconomiclosses. c. gooutofbusiness. d. Cannotbedeterminedwiththeinformationgiven. TABLE 8-2 Aperfectlycompetitiveproducerhasthefollowingshortrunaveragecostcurveandmarginal costcurve: SRAC=2Q+3 MC=4Q+3 wherecostsaremeasuredindollarsandQrepresentsthefirmsoutputinunits. 90. Ifthemarketpriceofwangdoodlesis$15each,theprofitmaximizingproducerwhose shortruncostcurvesaregiveninTable92shouldproduce______wangdoodles. a. 0 D,I b. 3 c. 6 d. 15 91. ThefirmwhoseshortruncostcurvesaregiveninTable82hasalongrunfixedcostof M,A a. $0. b. $2. c. $3. d. $4.

14 y Chapter 8/The Firm and the Industry Under Perfect Competition 92. Intheshortrun,perfectlycompetitivefirmscan a. makeaneconomicprofit. b. takealoss. c. breakeven. E,R d. Alloftheabovearecorrect.

FIGURE 8-3

93.

InFigure83,theprofitmaximizingfirmwilloperateatalevelof a. OJ. b. OG. E,A c. OI. d. OH. 94. InFigure83,theperfectlycompetitivefirmisrealizinga a. lossequaltoABCE. b. profitequaltoABCE. M,A c. profitequaltoABDF. d. lossequaltoABDF. 95. InFigure83,thefirmsminimumcostperunitoccursatanoutputof a. OJ. E,A b. OG. c. OI. d. OH.

Chapter 8/The Firm and the Industry Under Perfect Competition y 15 96. Inperfectcompetition,marginalrevenuealwaysequals a. totalrevenue. b. price. E,R c. averagecost. d. marginalfixedcost. 97. Aperfectlycompetitivefirmshouldcontinuetoexpandoutputuntil a. totalrevenueexceedstotalcosts. b. totalrevenueexceedsvariablecosts. E,R c. marginalrevenueequalsmarginalcosts. d. averagerevenueequalsvariablecosts. 98. Acompetitivefirmwillalwaysmaximizeprofitsbyproducingwhere a. perunitcostsarelowest. b. totalcostsandtotalrevenueareequal. E,R c. P=MC. d. P=AC.

FIGURE 8-4

99.

Figure84showstheindustryssupplyanddemandcurvesinpanel(1)andthecostcurves ofafirmintheindustryinpanel(2).AtS1,thefirmis a. shutdown. b. incurringlosses. c. earningzeroeconomicprofits. M,A d. earningeconomicprofitgreaterthanzero.

16 y Chapter 8/The Firm and the Industry Under Perfect Competition 100. Figure84showstheindustryssupplyanddemandcurvesinpanel(1)andthecostcurves ofafirmintheindustryinpanel(2).AtS2,thefirmis a. shutdown. b. incurringlosses. M,A c. earningzeroeconomicprofits. d. earningeconomicprofitgreaterthanzero. 101. Figure84showstheindustryssupplyanddemandcurvesinpanel(1)andthecostcurves ofafirmintheindustryinpanel(2).AtS3,thefirmis M,A a. shutdown. b. incurringlosses. c. earningzeroeconomicprofits. d. earningeconomicprofitgreaterthanzero. 102. Theperfectlycompetitivefirmsshortrunshutdownruleistoshutdownimmediatelyif a. TR<TC. b. TR<SRFC. M,A c. TR<SRVC. d. TR<MC>Q. 103. Atafirmsprofitmaximizinglevelofoutput,itspriceis$200anditsshortrunaverage totalcostis$225.Thefirm a. hasaprofitof$25perunitofoutput. b. shouldshutdownifitsshortrunaveragefixedcostislessthan$25. c. hasalossof$100perunitofoutput. D,I d. shouldshutdownifitsshortrunaveragevariablecostexceeds$25. 104. Afirmcanstayinbusinesswhiletakingalossintheshortrunaslongasitcoversits a. fixedcosts. M,R b. variablecosts. c. fixedandvariablecosts. d. Afirmcanneverstayinbusinesswhenitexperienceslosses. 105. Afirmwillshutdownif a. TRTC>TFC. b. TR+TC>TFC. D,A c. TCTR>TFC. d. TFC+TVC>TR. 106. Afirmwillshutdownintheshortrunif M,A a. P<AVC. b. P>AVC. c. AVC>AFC. d. TR>TC.

Chapter 8/The Firm and the Industry Under Perfect Competition y 17 107. Ifafirmshutsdownintheshortrun,itslossesareequalto a. TCTR. M,A b. TFC. c. TVC. d. MC. 108. Sunkcostsarecreatedintheshortrunby a. contractforlaborservices. b. leaseagreementonrealestate. c. purchasingmachinery. M,I d. Alloftheabovearecorrect. 109. Ifafirmshutsdown,its a. sunkcostsremainunchanged. b. revenuewillfalltozero. c. shortrunvariablecostswillfalltozero. M,I d. Alloftheabovearecorrect. 110. Theshortrunsupplycurveofaperfectlycompetitivefirm a. goesthroughthelowestpointonitsshortrunaveragetotalcostcurvebutnotonits shortrunaveragevariablecostcurve. b. goesthroughthelowestpointonitsshortrunaveragevariablecostcurvebutnoton itsshortrunaveragetotalcostcurve. M,A c. goesthroughthelowestpointonbothitsshortrunaveragevariablecostanditsshort runaveragetotalcostcurves. d. goesthroughthelowestpointonitsshortrunaveragetotalcostcurveandmayor maynotgothroughthelowestpointonitsshortrunaveragevariablecostcurve. 111. Inperfectcompetition,anincreaseinfixedcostswilleventuallycauseallexcept a. reductioninindustryoutput. D,A b. reductioninafirmsoutput. c. reductioninthenumberoffirms. d. decreaseinindustrysupply. 112. Theshortrunsupplycurveofthecompetitivefirmisthefirms a. MCcurve. b. AVCcurve. M,R c. MCcurveabovetheminimumpointontheAVCcurve. d. MCcurveabovetheminimumpointontheAFCcurve.

18 y Chapter 8/The Firm and the Industry Under Perfect Competition 113. IfthepricefallsbelowminimumSRAVC,thequantitysuppliedbythefirmwillbe a. thequantityatminimumMC. M,A b. zero. c. thequantityatthepointwhereMCintersectsAC. d. thequantityatminimumAC. 114. Thequantitywhichafirmwillsupplyintheshortrun a. canbereadfromitsaveragecostcurve. b. canbereadfromitsaveragevariablecostcurve. M,A c. canbereadfromthefirmsmarginalcostcurveaboveaveragevariablecost. d. isalwayszeroaboveminimumaveragevariablecost.

FIGURE 8-5

115. InFigure85,pointswhichlieonthefirmsshortrunsupplycurveare a. A,B,C. M,A b. C,D,H. c. F,E,G. d. A,C,H.

THE COMPETITIVE INDUSTRY

116. Thesupplycurveforacompetitiveindustryisobtainedby a. makinganempiricalstudyofhistoricaldata. b. verticallysummingthesupplycurvesoffirmsintheindustry. c. horizontallysummingtheaveragecostcurvesoffirmsintheindustry. M,R d. horizontallysummingthesupplycurvesoffirmsintheindustry.

Chapter 8/The Firm and the Industry Under Perfect Competition y 19 117. Theshortrunfortheindustryisdefinedasaperiod a. toobrieffornewfirmstoentertheindustry. b. toobriefforoldfirmstoleavetheindustry. c. inwhichthenumberoffirmsintheindustryisfixed. E,I d. Alloftheabovearecorrect. 118. Thelongrunfortheindustryisdefinedasaperiodoftimelongenoughfor a. anynewfirmthatdesirestoentertheindustry. b. anyoldfirmthatdesirestoleavetheindustry. c. allaspectsofproductiontovary,includingthenumberoffirmsintheindustry. E,I d. Alloftheabovearecorrect. 119. Whenafirmleavesaperfectlycompetitiveindustry, D,I a. theindividualdemandcurvesfacingremainingfirmsshiftupinthelongrun. b. shortrunindustryequilibriumisreestablishedatanewpointalongtheoriginal shortrunindustrysupplycurve. c. theshortrunindustrysupplycurveshiftstotheright. d. atthenewlongrunequilibrium,theremainingfirmsintheindustrywilleachreceive ahigherprofit. 120. Theshortrunsupplycurveofthecompetitiveindustryisfoundbysummingthe a. ACcurvesoftheindividualfirmsintheindustry. b. AVCcurvesoftheindividualfirmsintheindustry. M,I c. MCcurvesaboveAVCoftheindividualfirmsintheindustry. d. Thereisnoshortrunsupplycurveinacompetitiveindustry.

20 y Chapter 8/The Firm and the Industry Under Perfect Competition 121. Afirminaperfectlycompetitiveindustry a. isunaffectedbytheentranceofnewfirmsintotheindustry,sinceenteringfirmsaffect onlythepricestheythemselvesreceive. b. alwaysproducesmoreoutputinthelongrunthanintheshortrun. M,R c. maychooseadifferentinputmixinthelongrunthanintheshortrun. d. earnseconomicprofitinthelongrunbutnotintheshortrun.

FIGURE 8-6

122. Figure86showssupplyanddemandconditionsinaperfectlycompetitiveindustryand forafirminthatindustry.AssumetheindustryinitiallyhassupplycurveS1anddemand curveD1.IfdemandshiftstoD2,thenintheshortrunpricewill E,I a. risetoA. b. risetosomelevelbetweenAandB. c. remainatB. d. falltoC. 123. Figure86showssupplyanddemandconditionsinaperfectlycompetitiveindustryand forafirminthatindustry.Atapriceof$C,thefirmwould a. earnzeroeconomicprofit. M,A b. earnnegativeeconomicprofit. c. haveazeroopportunitycostofcapital. d. haveanegativeopportunitycostofcapital.

Chapter 8/The Firm and the Industry Under Perfect Competition y 21 124. Givenanindustrydemandcurve,QD=202P,andanindustrysupplycurve,QS=2+P, industryequilibriumpriceintheshortrunwillbe a. $20. b. $10. D,A c. $6. d. $3. 125. Givenanindustrydemandcurve,QD=202P,andanindustrysupplycurve,QS=2+P, industryequilibriumquantityintheshortrunwillbe a. 18. b. 12. c. 10. D,A d. 8. 126. Weexpectthedemandcurveintheperfectlycompetitiveindustrytobe E,R a. negativelysloped. b. vertical. c. horizontal. d. perfectlyelastic. 127. Whenafirmentersthesteelindustry,theshortrunequilibriumpriceofsteel E,A a. alwaysfalls. b. fallsonlyifexistingfirmsgangupontheentrant. c. fallsonlyifexistingfirmsareearningnoeconomicprofit. d. fallsonlyifthenewfirmismoreefficientthanexistingfirms. 128. Firmsenteringacompetitiveindustrywillcausethepriceoftheproductto E,A a. fall. b. rise. c. remainconstant. d. becomemoreresponsivetoconsumerdemand. 129. Perfectlycompetitivefirms______earnzeroeconomicprofitinlongrunequilibrium because______. a. always;firmsinperfectlycompetitiveindustriesalwaysmaximizeoutputandso floodthemarketuntiltheequilibriumpriceofoutputisdriventozero b. sometimes;thedemandcurveforanindividualperfectlycompetitivefirmmayor maynotcrossthecompanyslongrunaveragetotalcostcurveatitslowestpoint M,I c. always;firmsenterwhenevertheireconomicprofitispositiveandexitwheneverits negative,soinlongrunequilibriumeconomicprofitmustalwaysbezero d. never;nofirmwouldbewillingtoproduceifitreceivedzeroeconomicprofit

22 y Chapter 8/The Firm and the Industry Under Perfect Competition 130. Iftheopportunitycostofcapitalisbelowtherateofreturntocapitalintheperfectly competitivebeautysalonindustry, D,I a. resourceswillflowintotheindustry. b. beautysalonownersmustbeearningnegativeeconomicprofit. c. thebeautysalonindustrycannotbeinlongrunequilibrium. d. beautysalonownersmustbeearningnegativemarginalrevenueattheircurrentlevels ofoutput. 131. Thedifferencebetweenzeroprofitandzeroeconomicprofitisthat M,R a. economistsincludeopportunitycostinzeroeconomicprofit,whileaccountantsdonot includeopportunitycostinzeroprofit. b. economistsdonotincludeopportunitycostinzeroeconomicprofit,whileaccountants doincludeopportunitycostinzeroprofit. c. economistsincludeopportunitycostinzeroprofit,whileaccountantsdonotinclude opportunitycostinzeroeconomicprofit. d. economistsdonotincludeopportunitycostinzeroprofit,whileaccountantsdo includeopportunitycostinzeroeconomicprofit. 132. HelgaownsViking,Inc.,startedwithher$100,000inheritance.Helgasaccountantinforms herthatherfirmearnedaprofitof$100,000lastyear,andthatifshechoosestoinvestthe moneyshecanexpecta10%return.IfHelgadidnotrunViking,shewouldnotwork. WhatwereHelgaseconomicprofitslastyear? a. Zero b. $100,000 c. $90,000 D,A d. $95,000 133. RichardBlandquithisjobasanaccountingprofessortostarthisownrestaurant.Hegave upasalaryof$50,000peryearandwithdrew$100,000inbankCDsearning5percentto buyabuildingandequipment.Intherestaurantsfirstyearithaddirectexpensesof $75,000andrevenuesof$150,000.Therestaurantseconomicprofitwas a. $15,000. D,A b. $20,000. c. $75,000. d. notpossibletodeterminefromtheinformationgiven. 134. Aperfectlycompetitivefirmwouldbewillingtoremainintheindustryinthelongrunat zeroeconomicprofitbecause a. itwouldfindittoodifficulttoexitfromtheindustryinthelongrun. b. accountingprofitwouldbenegative. E,A c. revenueisequaltoallcosts,includingtheopportunitycostofcapitalandlabor. d. itssunkcostswouldpreventitfromleavingtheindustry.

Chapter 8/The Firm and the Industry Under Perfect Competition y 23 135. Zeroeconomicprofitsforaperfectlycompetitivefirminthelongrunmeans a. thefirmmustexittheindustry. E,A b. thefirmisinequilibrium. c. thefirmwillshutdownuntilthemarketimproves. d. averagerevenueisinsufficienttocoverlongrunaveragecost. 136. Longrunaveragecostoftheperfectlycompetitivefirmincludesthe a. costofrawmaterialsperunitofoutput. b. opportunitycostoflaborperunitofoutput. c. opportunitycostofcapitalperunitofoutput. M,I d. Alloftheabovearecorrect. 137. Whichofthefollowingstatementsisnottrueinaperfectlycompetitiveindustryinlong runequilibrium? D,I a. AprofitmaximizingfirmmayproduceanyoutputlevelatwhichP<LRAC. b. EveryfirmproducesatanoutputlevelatwhichMC=LRAC. c. Thereisnoentryorexitfromtheindustry. d. Nofirmearnsaneconomicprofit. 138. Theperfectlycompetitivewidgetindustryisinlongrunequilibrium.Aprofitmaximizing manufacturerreceivestotalrevenueof$55,000.Heuseshislabor,$15,000worthofwire, and$15,000worthofsteeltomakethewidgets.Themanufacturer a. isearninganeconomicprofitof$25,000. b. musthaveanopportunitycostoflaboroflessthan$25,000. D,A c. musthaveanopportunitycostoflaborofexactly$25,000. d. musthaveanopportunitycostoflaborofmorethan$25,000. 139. Theentryoffirmsintoacompetitiveindustrycausesthesupplycurveto a. increaseitsslope. b. decreaseitsslope. E,A c. movefarthertowardtheright. d. movetowardtheleft. 140. Anincreaseindemandwillcauseanincreaseinindustryoutputinthelongrunbecause M,I a. newfirmsentertheindustry. b. newfirmsentertheindustryandallfirmsincreasetheiroutput. c. allfirmsdecreasetheiroutputbutmorenewfirmsenter. d. nofirmsenterbuttheexistingfirmsincreasetheiroutput.

24 y Chapter 8/The Firm and the Industry Under Perfect Competition 141. Themarketforaperfectlycompetitiveindustryclearsatapriceof$3,andtheminimum averagecostforallfirmsis$2.50.Inthelongrun,wewouldexpectanincreasein a. eachfirmsoutput. M,A b. thenumberoffirms. c. eachfirmsprofit. d. eachfirmsaveragecost. 142. Thelongrunsupplycurveofanindustryequalstheindustrys a. longrunmarginalcostcurve. b. thehorizontalsumofallfirmssupplycurvesatanypointintime. D,R c. longrunaveragecostcurve. d. longruntotalvariablecostcurve. 143. Regardlessofquantityinlongrunequilibrium,theindustrypricecannotexceedthe M,R a. longrunaveragecostofsupplyingthatquantity. b. totalvariablecostofsupplyingthatquantity. c. longruntotalcostofsupplyingthatquantity. d. minimumlongrunmarginalcostofsupplyingthatquantity. 144. Thelongrunindustrysupplycurveinperfectcompetitionisderivedfromthe a. shortrunindustrysupplycurvewhichshiftsasnewfirmsentertheindustry. b. shortrunindustrysupplycurvewhichshiftsasoldfirmsexittheindustry. c. freedomoffirmsfromsunkcostssothatnewcostcurvesbecomelongruncurves. M,I d. Allanswersaboveareimportantinderivingthelongrunindustrysupplycurve. 145. Inaperfectlycompetitiveindustry,ifpriceexceedsLRAC,wemaybesure a. equilibriumhasnotbeenreached. b. newfirmswillcontinuetoentertheindustry. c. thelongrunindustrysupplycurvewillshifttotheright. E,I d. Alloftheabovearecorrect.

Chapter 8/The Firm and the Industry Under Perfect Competition y 25 146. Theprocessofadjustmenttoanewlongrunequilibriuminaperfectlycompetitive industryiscompletewhen a. nofirmswanttoenterorexittheindustry. b. everyfirmhasadjusteditsproductionprocesstomakethemostefficientuseofits resources. c. investorsintheindustryreceivethestandardeconomywiderateofreturnontheir investments. M,I d. Alloftheabovearecorrect.

FIGURE 8-7

147. InFigure87,thepriceatlongrunequilibriumis a. $5. b. $10. M,A c. $20. d. $35. 148. Atitslongrunequilibriumlevelofoutput,thedemandcurvefacinganindividual perfectlycompetitivefirmistangenttoits a. totaleconomicprofitcurve. M,A b. longrunaveragecostcurve. c. marginalcostcurve. d. marginalrevenuecurve.

26 y Chapter 8/The Firm and the Industry Under Perfect Competition 149. Firmswillcontinuetoenteracompetitiveindustryuntil a. thesupplycurveisvertical. b. thesupplycurveismeaningless. M,R c. anyexcessreturnshavebeencompetedaway. d. allresourcesarefullyemployed. 150. Aperfectlycompetitiveindustryinlongrunequilibriumisdescribedasefficientbecause firms M,R a. produceatthelowpointontheiraveragecostcurve. b. producewheremarginalcostyieldsaprofit. c. earnnomorethanthecostofcapital. d. arenotprofitable. 151. Ifyoumustdeterminethelongrunequilibriumoutputofacompetitivefirmandyouare permittedtoseeonlyonecurve,whichofthefollowingcurvesismosthelpful? a. demand b. marginalcost D,A c. averagecost d. averagefixedcost

Chapter 8/The Firm and the Industry Under Perfect Competition y 27

FIGURE 8-8

152. InFigure88,throughwhichpointmustahorizontaldemandcurvepasstoyieldalong runequilibrium? M,A a. A b. B c. C d. Alloftheaboveiscorrect. 153. InFigure88,outputatwhichpointrepresentsshortrunbutnotlongrunequilibrium? a. A M,I b. B c. C d. Alloftheaboveiscorrect.

28 y Chapter 8/The Firm and the Industry Under Perfect Competition

FIGURE 8-9

154. Figure89displaysthecostcurvesofaperfectlycompetitivefirm.Profitsatapriceof$10 wouldbeapproximately M,I a. $1perunit. b. $3perunit. c. $5perunit. d. $10perunit. 155. FortheperfectlycompetitivefirminFigure89,whatisthelongrunpriceandquantity? a. P=4,Q=150 M,A b. P=9,Q=200 c. P=10,Q=200 d. P=5,Q=150 156. Inthelongrun,theperfectlycompetitivefirminFigure89willleavetheindustryifthe pricefallsbelow a. $10. M,A b. $9. c. $5. d. $2. 157. Intheshortrun,thefirminFigure89willshutdownifthepricefallsbelow a. $8. b. $6. M,A c. $5. d. $1.

Chapter 8/The Firm and the Industry Under Perfect Competition y 29 158. Theentryofnewfirmsintoanindustrywillverylikely a. shifttheindustrysupplycurvetotheright. b. causethemarketpricetofall. c. reducetheprofitsofexistingfirmsintheindustry. E,I d. Alloftheabovearecorrect. 159. Inlongrunequilibriumunderperfectcompetition, a. thefirmandtheindustrywillhavethesamecostcurves. b. onlyaveryfewfirmswillbeearningeconomicprofits. M,A c. thedemandcurvesfacingindividualfirmswillfalltothelevelofminimumAC. d. individualfirmswilltendtoincreasetheiroutputs. 160. Whichofthefollowingstatementsconcerningequilibriuminthelongrunisnottrue? M,R a. Mostfirmsearneconomicprofitsinthelongrun. b. Thefirmcanvaryitsplantsizeinthelongrun. c. Economicprofitsareeliminatedasnewfirmsentertheindustryinthelongrun. d. Forfirmsinlongrunequilibrium,P=MC=AC.

PERFECT COMPETITION AND ECONOMIC EFFICIENCY

161. Inlongrunequilibrium,theperfectlycompetitivefirmproduces a. whereP=MC=AC. b. atthelowestpointonitslongrunaveragecostcurve. c. whereitslongrunaveragecostcurveistangenttoitshorizontaldemandcurve. M,I d. Alloftheabovearecorrect. 162. Themostefficientmarketstructureinthelongrunis E,R a. perfectcompetition. b. monopolisticcompetition. c. oligopoly. d. monopoly.

30 y Chapter 8/The Firm and the Industry Under Perfect Competition 163. Ifgovernmentforcedafirmtochargeapriceequaltomarginalcostinasituationwhere therearescaleeconomies, a. newfirmswouldentertheindustry. D,A b. thefirmwouldbeforcedtogobankrupt. c. positiveeconomicprofitwouldgrowevenlarger. d. marginalcostwouldexceedaveragecost.

WHICH IS BETTER TO CUT POLLUTIONTHE CARROT OR THE STICK?

164. Ataxonpollutingfirms M,A a. wouldshifttheLRACcurveupward. b. wouldshifttheLRACcurvedownward. c. wouldhavethesameimpactonthefirmasasubsidy. d. tendstohavetheperverseeffectofincreasingpollution. 165. Iftheobjectiveofeconomicpolicyistodecreasetheamountofpollutionbyanindustryin thelongrun,the a. mosteffectivepolicyactionwouldbeasubsidytofirmsforthereductionof emissions. M,A b. mosteffectivepolicyactionwouldbeataxonpollutingfirms. c. appropriatecourseofactionforgovernmentistodonothing. d. appropriatecourseofactionforgovernmentistoincreaseR&Doutlaystodevelop technologytoremovetheemissionsfromtheenvironment. 166. Asubsidytofirmsintendedtoreducepollutioninanindustrywould a. shifttheLRACcurveupward. b. havethesameimpactonthefirmasatax. c. likelydrivesomeexistingfirmsfromtheindustry. M,A d. likelyhavetheparadoxicaleffectofincreasingpollutionintheindustryinthelong run.

ESSAY QUESTIONS
167. Giveacompletebutconcisedefinitionofthefollowingterms. a. perfectcompetition b. perfectlycompetitivefirmsdemandcurve c. shutdownpoint d. longrunequilibriuminperfectcompetition ANSWERE,R

Chapter 8/The Firm and the Industry Under Perfect Competition y 31 a. Perfectcompetitionisamarketstructureinwhichtherearemanysmallfirmseach sellingahomogeneousproduct,withfreedomofentryandexitandcomplete information. Theperfectlycompetitivefirmsdemandcurveishorizontal,whichmeansitcansellas muchasitwishesattheprevailingmarketprice. Theshutdownpointforthefirmintheshortrunistheoutputpointwhereaverage revenueislessthanaveragevariablecost. LongrunequilibriumfortheperfectlycompetitivefirmisanoutputlevelsuchthatP=MC =ACandeconomicprofitiszero.

b. c. d.

168. Definethefollowingtermsandexplaintheirimportancetothestudyofeconomics. a. marginalcost b. marginalrevenue c. shortrunequilibrium d. supplycurveofthefirm e. economicprofit ANSWERE,R a. Marginalcostisthecosttothefirmofproducingandsellinganadditionalunitofthe good. b. Marginalrevenueistheamountofextrarevenuethefirmreceivesforproducingand sellingonemoreunitofagood. c. Shortrunequilibriumoccursinthetimeperiodinwhichsomecommitmentscannot bechanged.Thenumberoffirmsintheindustrycannotbechanged.Thecompetitive firmwillequatePtoMC>AVCtochooseprofitmaximizing(orlossminimizing) priceandoutput.IfpriceisbelowtheminimumofAVC,thefirmwillminimizelosses byshuttingdown. d. ThesupplycurveforthecompetitivefirmisMC>AVC.Ifpriceisbelowthe minimumofAVC,thefirmwillminimizelossesbyshuttingdown. e. Economicprofitequalsnetearnings,intheaccountantssense,minustheopportunity costofcapitalandofanyotherinputssuppliedbythefirmsowners.Itisassumed thatfirmsseektomaximizeeconomicprofits.Inacompetitiveindustryinthelong run,economicprofitsarezero. 169. Whataretheassumptionsofthemodelofperfectcompetition?Explainwhyeachis importantforshortrunandlongrunequilibrium. ANSWERM,R Therearefourassumptions: 1. Numeroussmallfirmsandcustomers.Eachbuyerandeachsellerissosmallthateachhas onlyanegligibleportionofthewholemarket.Therefore,noneisabletocontrolpriceor outputoftheindustry.

32 y Chapter 8/The Firm and the Industry Under Perfect Competition 2. Homogeneityofproduct.Or,noproductdifferentiation,includingbrandnamesor trademarks.Becausetheproductofferedbyanysellerisidenticaltothatofferedbyany otherseller,consumersdonotcarefromwhichfirmtheybuy.Therefore,noproduceris abletochargeapremiumprice. Freedomofentryandexit.Newfirmscanenterthemarketwithnoimpediments,andfirms areabletoleavetheindustrywithnoproblems.Ifthereareeconomicprofitsinthe industry,weexpectfirmstoenter,increasingindustrysupplyanddrivingpricelower. Perfectinformation.Eachfirmandeachcustomeriswellinformedabouttheavailable productsandprices.Theyareabletocomparepricesandseekthelowestprice. Theresultisthatthefirmhasnocontroloverpriceandisapricetaker.Marketdemand andmarketsupplydeterminetheprice.Thefirmwillmaximizeshortrunprofitsby equatingMR=P=MC>AVCandbyproducingatthequantityatwhichthisequilibrium occurs.IfP<minimumAVC,thefirmwillminimizelossesbyshuttingdown.Inthelong run,firmswillenterorleavetheindustrybasedonprofitopportunities,andtherewillbe noeconomicprofitsorlosses.Ifthepriceshouldriseorfallenoughtocauseeconomic profitsorlosses,therewillbeentryorexitoffirmsuntileconomicprofitsofallfirmsinthe industryarezero.

3.

4.

170. Ofthefollowingindustries,whichareperfectlycompetitive?Ofthosewhicharenot,why dotheynotfitthemodel? a. localbanking b. gasolinestations c. collegeleveleducationalinstitutions d. localradioandtelevision e. localfarmersmarket ANSWERM,I a. Localbankingisnot(generally)perfectlycompetitive.Insmalltowns,thereareatmost onlyafewbanks.Inlargercities,therearemorebanksfromwhichtochoose.Further, bankscompeteonimage,size,service,etc.,andnotalwaysonprice.Locationand hoursofservicemayvary. b. Gasolinestationsareclosetoperfectlycompetitive,butmanycustomerswillshopon thebasisofbrandnames.Ifso,theindustryismonopolisticallycompetitive. c. Collegesaredifferentiated.Theyaregenerallydistinguishedbysize,qualityof instruction,etc.Thisisanexampleofmonopolisticcompetition. d. Localradioandtelevisioncanbeoligopolisticinmanysmallermarketsandcloseto monopolisticcompetitioninlargemarkets.Differentiationiscommon,withdifferent formats(talk,classical,rock,etc.). e. Localfarmersmarketsareprobablytheclosesttoperfectcompetitiononthelist.Each buyerandsellerissmallrelativetothemarket;produceisnotusuallydifferentiated; andallareabletoshopquicklyandeasilytocomparepriceandoutputquality.

Chapter 8/The Firm and the Industry Under Perfect Competition y 33 171. Whystudyperfectcompetition,ifitrarelyexists? ANSWERE,R Perfectcompetitionisthecircumstancewherethemarketperformsbest,demonstrating AdamSmithsinvisiblehandinaction.Eachfirm,actinginitsownselfinterestthe pursuitofmaximumprofitendsupactinginsocietysbestinterest;productsare producedandsoldatminimumaveragecostinthelongrun.Also,eveniftheconditions ofthemodelarenotfulfilled,firmsmaystillactasiftheassumptionsheld.Sothemodels predictivepowermayextendbeyondthecasesofagriculturalandstockmarkets. 172. Drawagraphillustratingtherelationshipbetweenthedemandcurveoftheperfectly competitivefirmandtheperfectlycompetitiveindustry.Labelallcurvesandaxes correctly. ANSWERM,I ThediagramofthefirmandindustryshouldlooklikeFigure81inthetext.Thefirms demandcurveshouldbehorizontalattheindustryequilibriumprice. 173. Whydoesntacompetitivefirmreduceitspricebelowtheindustrypricetoincreasesales? ANSWERE,A Acompetitivefirmcansellallitwishesatthegoingindustryprice;thatisthemeaningofa horizontaldemandcurve.Therewouldbenopointtocharginglessifonecansellallone wantsatahigherprice.Furthermore,suchapolicywouldresultinlossesinthelongrun, whereindustrypriceresultsinzeroeconomicprofitsandanylowerpricewouldresultin losses. 174. Whydoesntaperfectlycompetitivefirmchargeapriceslightlyhigherthantheindustry priceinordertoearnextraprofit? ANSWERE,A Aperfectlycompetitivefirmisproducingaproductthatisidenticaltotheoutputofeach ofitscompetitors.Additionally,itisonlyonefirmofmanyinthemarket.Thus,nobuyer wouldpayapriceabovetheindustryrateinordertobuyfromoneparticularfirm; instead,theconsumerwouldsimplybuyfromoneofthemanyotherfirms. 175. Whatmakesthedemandcurveoftheperfectlycompetitivefirmuniquelydifferentfrom thatoffirmsinotherkindsofmarketstructures? ANSWERE,R Theperfectlycompetitivefirmsdemandcurveishorizontal,whichmeansitcansellas muchasitwantsatthemarketprice.Thisispossiblebecauseeachfirmunderperfect competitionissoinsignificantrelativetothemarketasawholethatithasnoinfluence overprice;itisapricetaker. 176. Whatisthedifferencebetweentheshortrunandthelongrunaseconomistsdefinethe two? ANSWERE,R

34 y Chapter 8/The Firm and the Industry Under Perfect Competition Theshortrunisaperiodoftimewithinwhichatleastoneresourceisfixed.Itcouldbea commitmentforarentallease,forexample.Theshortrunisalsoaperiodtooshortfornew firmstoentertheindustryorforfirmscurrentlyintheindustrytoexit.Forthelongrun period,allresourcesmayvary;hence,allcostsarevariablecosts.Newfirmsmayenterthe industryandoldfirmsmayexit. 177. Drawagraphillustratingacompetitivefirminshortrunequilibriumthatisearningan economicprofit.Besuretolabelallcurvesandaxescorrectly. ANSWERD,I ThediagramshouldlooklikeFigure82inthetext.Notethatpricemustbehigherthan theminimumofaveragecost. 178. Ifafirmhasshortrunlosses,willitstayopen?Underwhatconditionswillafirmclosein theshortrun?Explain. ANSWERD,A ThefirmsufferslossesifP<ACsothatrevenuedoesnotcovercosts.Thefirmwillstay openifP>minimumofAVC.Ifthefirmshutsdown,revenuefallstozerobutfixedcosts continueasobligationsofthefirm.Therefore,ifP>minimumofAVC,thefirmcancover itsvariable(avoidable)obligationsandaportionoffixed(unavoidable)obligations.Sucha decisioncutslosses,sothatitismoreprofitabletoproducethantoclose.However,ifP< minimumofAVC,thefirmshouldclose.Revenueisinsufficienttocovervariable (avoidable)costs,muchlesscoversomeportionoffixed(unavoidable)costs.Loss minimizationinthiscaserequiresclosingdown. 179. Explainthereasoningbehindtheshutdownrules.Whenisitappropriatetooperatewitha loss? ANSWERM,I 1. Thefirmwillmakeaprofitiftotalrevenue(TR)exceedstotalcost(TC).Inthatcase,it shouldnotplantoshutdowneitherintheshortrunorinthelongrun. 2. ThefirmshouldcontinuetooperateintheshortrunifTRexceedsshortrunvariable cost(TVC).ItshouldplantocloseinthelongrunifTRislessthanTC. Thefirstrulerequiresnoexplanation.Thesecondrulereliesonthedistinctionbetween fixedandvariablecosts.Thefirmcanavoidvariablecostsintheshortrunbyshutting down.However,itisunabletoavoidfixedcostsbyshuttingdown.Ifafirmshutsdown, itslosseswillequaltheamountofitsfixedcosts.Ifrevenueexceedstotalvariablecost(or, equivalently,ifpriceexceedstheminimumofaveragevariablecost),thefirmshould operate,payallvariablecostsandsomeportionoffixedcosts,tominimizelosses. 180. Iftherearenoprofitsincompetitiveequilibrium,whydofirmsproduce?Howcanthey stayinbusiness? ANSWERE,I

Chapter 8/The Firm and the Industry Under Perfect Competition y 35 Thenoprofitsconclusionofcompetitionreferstoeconomicprofitsthereisnoexcess rateofreturntothetypicalfirm.However,eachfirmisabletoearnsufficientaccounting profitstocovertheopportunitycostofinvestedfactorsandtocontinueoperating.The sourceoftheconfusionisfailingtodistinguishbetweenaccountingandeconomicprofits. 181. Afirmsellsinacompetitivemarketinwhichpriceis$10.Itsmarginalcostis2+.5Q. Determinetheprofitmaximizinglevelofoutput. ANSWERM,A ThesolutionrequiresequatingP=MCtodetermineQ: P=10=MC=2+.5Q 10=2+.5Q 8=.5Q Q=16 182. Afirmsellsinacompetitivemarketinwhichpriceis$12.Itsmarginalcostis6+.25Q. Determinetheprofitmaximizinglevelofoutput. ANSWERM,A ThesolutionrequiresequatingP=MCtodetermineQ: P=12=MC=6+.25Q 12=6+.25Q 6=.25Q Q=24 183. Describetheprocessthatwouldoccurinthelongruninacompetitiveindustryifthere wereeconomicprofits.Illustratethiswithadiagram. ANSWERM,I ThediagramshouldlooklikeFigure87inthetext.Ifthereareeconomicprofits,firmswill entertheindustry.Theindustrysupplywillincreaseandthepricewillfall.Astheprice falls,theprofitsofeachfirmwillfall.The(representative)firmwillthereforecutoutput, movingdownwardonitsmarginalcostcurve.Theprocessofentrywillendwheneach firmisatthebottomofaveragecostsothattherearenoeconomicprofits. 184. Drawagraphshowingthetypicalcompetitivefirmlosingmoneybutcontinuingto operate.Explainwhythefirmcontinuestooperateratherthanshutdown. ANSWERM,I

36 y Chapter 8/The Firm and the Industry Under Perfect Competition Figure810showsprice(=MR)aboveminimumAVCbutbelowminimumAC.Thefirm islosingmoneybutlessmoneythanifitshutsdown.SincepriceexceedsAVC,itis coveringallitsvariablecostsandhasfundsleftover,whichcancoveraportionoffixed cost.Ifthefirmshutsdown,itlosesallitsfixedcost.

FIGURE 8-10

Chapter 8/The Firm and the Industry Under Perfect Competition y 37 185. Graphicallyshowafirmearningaprofit;shadetheappropriateprofitrectangle.Explain howtheprofitformularepresentedbytherectangleisanalogoustoTRTC. ANSWERE,A Figure811showsprice(=MR)aboveminimumAC.ThefirmoperatesatthequantityQc whereP=MC.Theshadedrectangleis(PcACc)Qc.ThisissimplyarestatementofTR TC,sinceTR=P QandTC=AC Q.

FIGURE 8-11

38 y Chapter 8/The Firm and the Industry Under Perfect Competition 186. AfirmsminimumACis$10,itsminimumAVC$7.Showthisfirmsshortrunsupply curve,explaininghowyouobtainedit. ANSWERM,I DrawaUshapedACandAVC,withQatminimumAVCatasmallerlevelthanforAC (Figure812).MCpassesthrougheachoftheseminimumpoints.Thefirmsshortrun supplyisMCaboveminimumAVC.BelowminimumAVC,thefirmproduceszero.Only whenPexceedsminimumAVCwillthefirmfinditworthwhiletooperate;below minimumAVCthefirmisbetteroffshuttingdownandlosingitsfixedcost.

FIGURE 8-12

Chapter 8/The Firm and the Industry Under Perfect Competition y 39 187. Ifthetypicalfirmsminimumaveragevariablecostis$10atanoutputof50units,if marginalcostis$20at70units,andthereare1,000firmsintheindustry,sketchsupply curvesforthetypicalfirmandfortheindustryasawhole. ANSWERM,I Forthefirm,plottwosupplypointscorrespondingtoP=$10andQ=50,P=$20andQ= 70(Figure813).Fortheindustry,multiplytheQsby1,000,sothatindustryQ=50,000at P=$50andindustryQ=70,000atP=$20.

FIGURE 8-13

188. Therearecurrently1,000firmsinacompetitiveindustry.Minimumlongrunaveragecost is$80andprice$100.Explainwhatwillhappentoprice,profit,andthenumberoffirmsin thisindustryovertime. ANSWERE,I Priceexceedsminimumlongrunaveragecost,sothatfirmsareearninganeconomic profit.Thiswillinduceadditionalentryovertime.Assupplyincreases(rightwardshift), pricewillfalltominimumlongrunaveragecostof$80.Economicprofitwilldroptozero. 189. Howdoesafirmthatislosingmoneyintheshortrundecidewhethertoshutdownor continuetoproducetominimizeitslosses? ANSWERM,A ThefirmshouldcontinuetoproduceintheshortrunifTRexceedsTVC;ifTRfallsbelow TVC,thefirmshouldshutdown.

40 y Chapter 8/The Firm and the Industry Under Perfect Competition 190. SallyRandownsaceilingfancompany.Shesells1,000ceilingfansat$50each.Eachfan costsher$20.Sheusesherownmoneytobuythefans;shewithdrawsthemoneyfromher savingsaccountwhereitearns5percentinterest.Beforegoingintotheceilingfan business,sheworkedasafandancerat$25,000ayear.ShouldSallyremaininbusiness? ANSWERM,A Ifhereconomicprofitisatleastzero,Sallyshouldstayinbusiness.HerTR=$50,000and hertotalaccountingcostis$20,000,foranaccountingprofitof$30,000.Sheforgoesinterest onsavingsof$20,000(.05)=$1,000aswellasforgoneearningsof$25,000.Thisleaves $4,000ineconomicprofit,sosheshouldstayinbusiness. 191. Explainhowtheshortrunsupplycurveofthecompetitivefirmisderived. ANSWERM,A Sincethefirmiseitherminimizinglossesormaximizingprofitintheshortrunifit produceswhereMC=PaboveminimumAVCforanypriceaboveminimumAVC,the quantitycansimplybereadofftheMCcurve.ThustheMCcurveaboveminimumAVC becomesthefirmsshortrunsupplycurve. 192. ExplainwhyAdamSmithbelievedthatcompetitivemarketsareakeycomponentof achievingthegainsfromtheinvisiblehand. ANSWERE,R AdamSmithbelievedthatindividualsactingintheirownselfinterestwouldendup actinginsocietysbestinterest.Thisprocessisborneoutbycompetition,inwhichfirms pursuingmaximumprofitendupproducingagoodatthelowestpossibleACandselling itatapriceequaltotheminimumLRAC. 193. Explainhowtheshortrunindustrysupplycurveforaperfectlycompetitivemarketis derived. ANSWERE,A Atanygivenprice,thequantitiessuppliedbyindividualfirmsaresimplyadded.The resultingcurveisahorizontalsummationofalltheindividualfirmssupplycurves. 194. Explainwhytaxesonpollutantsreducepollutionwhilesubsidiestofirmscuttingtheir pollutantsactuallyincreasepollution. ANSWERM,I Taxescauseanincreaseincostandaleftwardshiftofsupply.Outputdecreasesandthere islesspollution.Subsidiescauseindividualfirmstocuttheiremissions,buttheyalso induceadditionalfirmsintothemarket.Sincecostsofproductiondecrease,thenew equilibriumoutputwillincrease. 195. Showwhathappenstotheindustryequilibriumwhennewfirmsenteraperfectly competitivemarketinthelongrun. ANSWERM,A

Chapter 8/The Firm and the Industry Under Perfect Competition y 41 ThediagramoftheprocessshouldbesimilartoFigure87inthetext.Theindustrysupply curveshiftsoutwardandindustrypricefalls. 196. Whatistherelationshipbetweenthelongrunindustrysupplycurveandtheshortrun supplycurveinaperfectlycompetitivemarket? ANSWERM,A Thelongrunindustrysupplycurveevolvesfromtheshortrunsupplycurve.Asnew firmsenter,theshortrunsupplycurveshiftstowarditslongrunposition.Also,asshort runfixedcostcommitmentsbecomevariable,theshortruncostcurvesbecomethelong runcostcurve. 197. ToownataxicabinNewYorkCity,youmustownamedallion.NewYorkCityregulates thenumberofofficialcabsbylimitingthenumberofmedallions.ExplainwhytheNew Yorkcabindustryisnotcompetitivebyreviewingthefourconditionsnecessaryfor competition.NYCviolateswhichone? ANSWERE,I Productionisbymanyfirms,eachsellinganidenticalproduct.Therearenobarriersto entryorexit,andconsumersandproducershaveperfectinformation.Themedallionisa barriertoentrytonewfirms,whichcanonlyentertheindustrybybuyingamedallion fromexistingtaxicabowners. 198. Whatisthedifferencebetweentheaccountantsconceptofprofitandtheeconomistsview ofprofit? ANSWERE,A AccountantstendtoincludeinTCcontractualcostsonly.TheeconomistmeasuresTCas thecostofallthefirmsinputs,includingtheopportunitycostofthecapitaloranyother inputs,suchaslabor,providedbythefirmsowners.Accountingprofitisgenerallylarger thaneconomicprofit,sothatpositiveaccountingprofitmaycorrespondtozeroeconomic profit. 199. Illustratethecostcurvesandaveragerevenue(demand)curvefortheperfectly competitivefirminlongrunequilibrium. ANSWERE,I TheillustrationshouldlooklikeFigure89(a)inthetext. 200. Whydoeconomistsconsiderperfectcompetitiontobethemostefficientmarketstructure? ANSWERE,R Perfectcompetitionisthemostefficientmarketstructurebecause,inthelongrun,each firminthemarketwillbeproducingatitsminimumaveragecost,orperunitcost(see Figure89ainthetext,forexample).Thismeansthatconsumersgetdesiredgoodsand servicesatthelowestpossibleprices,andalsothatthefirmsareeconomizingonsocietys scarceresourcestothegreatestextentpossible.