Chapter 12-ECON
Why are consumers so powerful in a market system?
Because it is consumers' demand that influences the market price and dictates what producers will supply in the market.
What is the supply curve for a perfectly competitive firm in the short run? The supply curve for a firm in a perfectly competitive market in the short run is
that firm's marginal cost curve for prices at or above average variable cost.
A columnist for the Wall Street Journal discussed how some firms were buying existing drilling operations in Canadian oil sands regions. These operations would not be profitable to build from scratch but were profitable to operate given that they were already built because, as the columnist said: "The key is the distinction between fixed and variable costs. While the fixed investment in new oil sands projects is prohibitive, variable costs can be in the low $20 range (say, $24) per barrel." The columnist estimated that the fixed cost of a new oil sands drilling operation could be $95 per barrel. At the time the column was written, the price of oil was about $50 per barrel. Assuming that the variable cost of an existing oil sands operation is $24 per barrel and the price of oil is $50 barrel, the companies selling their operations were losing ____nothing per barrel. (Enter your response as a whole number and include a minus sign.)
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Why do single firms in perfectly competitive markets face horizontal demand curves?
.With many firms selling an identical product, single firms have no effect on market price.
Suppose an assistant professor of economics is earning a salary of $65,000 per year. One day she quits her job, sells $90,000 worth of bonds that had been earning 4 percent per year, and uses the funds to open a bookstore. At the end of the year, she shows an accounting profit of $90,000 on her income tax return. What is her economic profit? Her economic profit for the year is ___ (round your answer to the nearest dollar).
21,400
Which of the following statements is true when the difference between TR and TC is at its maximum positive value?
A. MR = MC B.Slope of TR = Slope of TC Both A and B are true.
According to an article in the Wall Street Journal, in 2007 the insurance company AXA Equitable signed a long-term lease on 2 million square feet of office space in a skyscraper on Sixth Avenue in Manhattan in New York City. In 2013, AXA decided that it only needed 1.7 million square feet of office space, so it subleased 300,000 square feet of space to several other firms. Although AXA is paying a rent of $88 per square foot on all 2 million square feet it is leasing, it is only receiving $40 per square foot from the firms subleasing the 300,000 square feet. AXA's actions might make economic sense in the short run if AXA's AXA's actions could make economic sense in the long run if AXA's
A. variable cost per square foot was equal to or less than $40. B. total cost per square foot is equal to $40 or less.
When are firms likely to enter an industry? When are they likely to exit?
Economic profits attract firms to enter an industry, and economic losses cause firms to exit an industry.
A student examines the graph to the right and argues, "I believe that a firm will want to produce at Q1, not Q2. At Q1, the distance between price and marginal cost is the greatest. Therefore, at Q1, the firm will be maximizing its profits." Is the student's argument correct or incorrect?
Incorrect. Profits are maximized at the quantity where marginal revenue equals marginal cost.
Is the following statement correct or incorrect? "According to the model of perfectly competitive markets, the demand for wheat should be a horizontal line. But this can't be true: When the price of wheat rises, the quantity of wheat demanded falls, and when the price of wheat falls, the quantity of wheat demanded rises. Therefore, the demand for wheat is not a horizontal line."
Incorrect. The commentator is confusing the market demand for wheat with the demand line facing the representative firm.
By 2017, McDonald's had stopped selling Chicken McNuggets and other products made from chickens fed antibiotics. The change increased McDonald's costs, but an article in the Wall Street Journal noted that "...McDonald's ability to raise its prices is limited because of stiff competition." Does this "stiff competition" mean that the demand curve for McDonald's Chicken McNuggets is horizontal? Briefly explain.
No, the demand curve is not horizontal because Chicken McNuggets are not identical to other chicken products.
"In a perfectly competitive market, in the long run consumers benefit from reductions in costs, but firms don't." Don't firms also benefit from cost reductions because they are able to earn greater profits?
No. Because short-run profits encourage entry, firms earn zero economic profit in the long run.
Refer to the graph to the right of the demand curve facing a firm in the perfectly competitive market for wheat. The fact that the demand curve is horizontal implies which of the following?
The firm can sell any amount of output as long as it accepts the market price of $7.00.
The financial writer Andrew Tobias has described an incident when he was a student at Harvard Business School: Each student in the class was given large amounts of information about a particular firm and asked to determine a pricing strategy for the firm. Most of the students spent hours preparing their answers and came to class carrying many sheets of paper with their calculations. When his professor called on him in class for an answer, Tobias stated, "The case said the XYZ Company was in a very competitive industry . . . and the case said that the company had all the business it could handle." Given this information, what price do you think Tobias argued the company should charge? (Tobias says the class greeted his answer with "thunderous applause.")
The market price.
The chapter states, "Firms will supply all those goods that provide consumers with a marginal benefit at least as great as the marginal cost of producing them." A student objects to this statement by making the following argument: "I doubt that firms will really do this. After all, firms are in business to make a profit; they don't care about what is best for consumers." After reminding the class that we are assuming a competitive market, your professor would most likely give the following reply.
While it's true that firms don't care about consumer welfare, they do maximize profits by producing the efficient level of output.
A buyer or seller that is unable to affect the market price is called
a price taker.
a. Which of the following best explains why firms don't maximize revenue rather than profit? b. If a firm decided to maximize revenue, would it be likely to produce a smaller or a larger quantity than if it were maximizing profit? The firm would produce a ____quantity of output.
a. At the point where revenue is maximized, the difference between total revenue and total cost may not be maximized b. larger
What is a price taker? a. A price taker is b. When are firms likely to be price takers? A firm is likely to be a price taker when
a. a firm that is unable to affect the market price. b. it represents a small fraction of the total market
Suppose that the market for gluten-free spaghetti is in long-run equilibrium at a price of $3.50 per box and a quantity of 4 million boxes sold per year. Assume that the production of gluten-free spaghetti is a constant-cost industry. If the demand for gluten-free spaghetti increases permanently, which of the following combinations of equilibrium price and equilibrium quantity would you expect to see in the long run?
b. After demand increases, and supply increases, the quantity will be more than 4 million boxes, but the price will return to its initial level.
How is the market supply curve derived from the supply curves of individual firms? The market supply curve
by horizontally adding the individual firms' supply curves.
Explain why it is true that for a firm in a perfectly competitive market that P = MR = AR. In a perfectly competitive market, P = MR = AR because
firms can sell as much output as they want at the market price.
Suppose that, at the beginning of the year, the price of corn is $3.80 per bushel and 14 billion bushels are harvested. There are approximately 400,000 corn farmers, so the average output per farmer is about 35,000 bushels At the beginning of the year, the average corn farmer produced ____%of the total corn production. (Enter your response rounded to five decimal places.)
he average farmer produced 35,000 bushels out of 14 billion. (35,000/14,000,000,000)×100 = 0.00025%.
In a perfectly competitive industry with constant costs, the long-run supply curve will be
horizontal
What is meant by allocative efficiency? Allocative efficiency is when every good or service
is produced up to the point where the marginal benefit for consumers equals the marginal cost of producing it.
The late Nobel Prize-winning economist George Stigler once wrote, "the most common and most important criticism of perfect competition... [is] that it is unrealistic." Despite the fact that few firms sell identical products in markets where there are no barriers to entry, economists believe that the model of perfect competition is important because
it is a benchmark—a market with the maximum possible competition—that economists use to evaluate actual markets that are not perfectly competitive.
What are the three conditions for a market to be perfectly competitive? For a market to be perfectly competitive, there must be
many buyers and sellers, with all firms selling identical products, and no barriers to new firms entering the market.
Explain why it is true that for a firm in a perfectly competitive market, the profit-maximizing condition MR = MC is equivalent to the condition P = MC. When maximizing profits, MR = MC is equivalent to P = MC because
the marginal revenue curve for a perfectly competitive firm is the same as its demand curve.
Would a firm earning zero economic profit continue to produce, even in the long run? In long-run competitive equilibrium, a firm earning zero economic profit
will continue to produce because such profit is as high a return as could be earned elsewhere.
In perfect competition, long-run equilibrium occurs when the economic profit is
zero.
Suppose you decide to open a copy store. You rent store space (signing a one-year lease), and you take out a loan at a local bank and use the money to purchase 10 copiers. Six months later, a large chain opens a copy store two blocks away from yours. As a result, the revenue you receive from your copy store, while sufficient to cover the wages of your employees and the costs of paper and utilities, doesn't cover all of your rent and the interest and repayment costs on the loan you took out to purchase the copiers. Should you continue operating your business?
Yes, because you are covering your variable costs.
What is the relationship between a perfectly competitive firm's marginal cost curve and its supply curve?
A firm's marginal cost curve is equal to its supply curve for prices above average variable cost.
A student argues: "To maximize profit, a firm should produce the quantity where the difference between marginal revenue and marginal cost is the greatest. If a firm produces more than this quantity, then the profit made on each additional unit will be falling." Is the above statement true or false?
False. Profit is maximized at the output level where marginal revenue equals marginal cost.
Suppose you read the following item in a newspaper article, under the headline "Price Gouging Alleged in Pencil Market": Consumer advocacy groups charged at a press conference yesterday that there is widespread price gouging in the sale of pencils. They released a study showing that whereas the average retail price of pencils was $1.00, the average cost of producing pencils was only $0.50. "Pencils can be produced without complicated machinery or highly skilled workers, so there is no justification for companies charging a price that is twice what it costs them to produce the product. Pencils are too important in the life of every American for us to tolerate this sort of price gouging any longer," said George Grommet, chief spokesperson for the consumer groups. The consumer groups advocate passage of a law that would allow companies selling pencils to charge a price no more than 20 percent greater than their average cost of production. Which of the following is not likely to happen in the pencil market?
Firms will charge a cost above marginal cost in the long run.
Which of the following terms best describes the result of the forces of competition driving the market price to the minimum average cost of the typical firm?
productive efficiency
What is the difference between a firm's shutdown point in the short run and its exit point in the long run? a. In the short run, a firm's shutdown point is the minimum point on the b. Why are firms willing to accept losses in the short run but not in the long run?
a. average variable cost curve, while in the long run, a firm's exit point is the minimum point on the average total cost curve. b. There are sunk costs in the short run but not in the long run.
How does perfect competition lead to allocative and productive efficiency? Perfect competition leads to allocative and productive efficiency
a. because prices reflect consumer preferences. b. because firms are motivated by profit.
An article in the Wall Street Journal discussing the financial results for General Electric Co. (GE) for the first quarter of 2017 reported that, compared with the same quarter in the previous year, the firm's revenue had fallen from $27.94 billion to $27.66 billion, while its profit had increased from $228 million to $653 million. a. It is possible for profits to increase even if revenue decreases if b. How can GE best maximize its profit?
a. costs decrease more than revenue decreases. b. Increase revenues and cut costs.
a. The increase in total revenue that results from selling one more unit of output is b. What is the relationship between price, average revenue, and marginal revenue for a firm in a perfectly competitive market?
a. marginal revenue b.Price is equal to both average revenue and marginal revenue
The following questions are about long-run equilibrium in the market for cage-free eggs. a.As described in the chapter opener, the market for cage-free eggs in 2015 was b.In the long run in the market for cage-free eggs, we would expect
a. not in equilibrium because farmers who were raising cage-free chickens were earning higher profits than farmers who raised chickens using more traditional methods. b. the equilbrium price to decrease and the equilibrium quantity to increase, as more firms enter.
The following questions are about long-run equilibrium in the market for cage-free eggs. a. As described in the chapter opener, the market for cage-free eggs in 2015 was b.In the long run in the market for cage-free eggs, we would expect
a. not in equilibrium because farmers who were raising cage-free chickens were earning higher profits than farmers who raised chickens using more traditional methods. b.the equilibrium price to decrease and the equilibrium quantity to increase, as more firms enter.
Which of the following terms best describes a state of the economy in which production reflects consumer preferences? Long-run equilibrium in perfect competition results in
allocative efficiency allocative and productive efficiency
An article in the Wall Street Journal discusses the visual effects industry, which is made up of firms that provide visual effects for films and television programs. The article notes that: "Blockbusters... often have thousands of visual effects shots. Even dramas and comedies today can include hundreds of them." But the article notes that the firms producing the effects have not been very profitable. Some firms have declared bankruptcy, and the former general manager of one firm was quoted as saying: "A good year for us was a 5% return." What dynamics best describe the factors at play in this market? Market entry for visual effect companies is relatively
easy, so firms can expect to earn zero economic profit in the long run
In 2017, two beer drinkers in California filed a lawsuit against Kona Brewing Company, which sells Kona beer. The beer drinkers claimed that Kona was marketed as if it were brewed in Hawaii, but the beer is actually brewed in Oregon, Washington, Tennessee, and New Hampshire. If the market for beer were perfectly competitive, the location of breweries would
not matter to consumers since the product would be homogeneous
In a perfectly competitive industry with increasing average costs, the long-run supply curve will be
upward-sloping
What is meant by productive efficiency? Productive efficiency is
when a good or service is produced at lowest possible cost
Hedrick Smith was a foreign correspondent for the New York Times who lived in the Soviet Union in the 1970s, a period when the country had a planned economy rather than a market system. In a book he wrote about everyday life in the Soviet Union, Smith made the following observations about shopping in Moscow: At first it seemed...that the stores were pretty well stocked. Only as we began to shop in earnest...did the Russian consumer's predicament really come through to me. First, we needed textbooks for our children...and found that the sixth-grade textbooks had run out.... We tried to find ballet shoes for our 11-year-old daughter...only to discover that in this land of ballerinas, ballet shoes size 8 were unavailable in Moscow.... I tried to find shoes for myself. They were out of anything in my size but sandals or flimsy, lightweight shoes that the clerk, with one look at me, recommended against buying. "They won't last," he admitted. Judging by Smith's observations, did the Soviet Union achieve allocative efficiency in the production of sixth-grade textbooks, ballet shoes, and men's shoes? Briefly explain.
No, it did not achieve allocative efficiency because the marginal benefit was greater than the marginal cost of production.
