ECN 212 - CH 14 competitive firms

Why must the long-run equilibrium in a competitive market (with free entry and exit) have all firms operating at their efficient scale?

In the long-run equilibrium, firms must be making zero economic profits so that firms are not entering or exiting the industry. Zero profits occur when , and for the competitive firm determines the production level. only at the minimum of ATC.

Why is the short-run market supply curve upward sloping while the standard long-run market supply curve is perfectly elastic?

In the short run, firms cannot exit or enter the market, so the market supply curve is the horizontal sum of the upward-sloping MC curves of the existing firms. However, in the long run, if the price is above or below minimum ATC, firms will enter or exit the market causing the price to always return to minimum ATC for each firm, but the total quantity supplied in the market rises and falls with the number of firms. Thus, the market supply curve is horizontal.

What constitutes a competitive firm's long-run supply curve? Explain.

It is the portion of the firm's marginal-cost curve that lies above its average-total-cost curve because the firm maximizes profit where , and in the long run, the firm must cover its total costs or it should exit the market.

What constitutes a competitive firm's short-run supply curve? Explain.

It is the portion of the firm's marginal-cost curve that lies above its average-variable-cost curve because the firm maximizes profit where , and in the short run, fixed or sunk costs are irrelevant and the firm must only cover its variable costs.

Under what conditions would the long-run market supply curve be upward sloping?

If an input necessary for production is in limited supply or if firms have different costs.

In the long run, if the price firms receive for their output is below their average total costs of production, some firms will exit the market.

T

In the short run, the market supply curve for a good is the sum of the quantities supplied by each firm at each price.

T

Average Revenue

TR/Q

Marginal Revenue

The change in total revenue from an additional unit sold

Which of the following markets would most closely satisfy the requirements for a competitive market? Answer gold bullion electricity cable television soda All of the above represent competitive markets.

gold bullion

What are the three conditions that characterize a competitive market?

-There are many buyers and sellers -the goods offered for sale are largely the same -firms can freely enter or exit the market.

Sunk Cost

A cost to which one is already committed and is not recoverable

Exit

A long-run decision to permanently cease production and leave the market

Competitive Market

A market with many buyers and sellers trading identical products so that each buyer and seller is a price taker

Shut Down

A short-run decision to temporarily cease production during a specific period of time due to current market conditions

Price Takers

Buyers and sellers in a competitive market that must accept the price that the market determines

In the long run, if firms are identical and there is free entry and exit in the market, all firms in the market operate at their efficient scale.

T

A competitive firm's long-run supply curve is the portion of its marginal-cost curve that lies above its average-variable-cost curve.

F it is the portion of the MC curve that lies above its average-total-cost curve.

A competitive firm's short-run supply curve is the portion of its marginal-cost curve that lies above its average-total-cost curve.

F it is the portion of the MC curve that lies above its average-variable-cost curve.

If marginal cost exceeds marginal revenue at a firm's current level of output, the firm can increase profit if it increases its level of output.

F the firm increases profits if it reduces output.

In the short run, if the price a firm receives for a good is above its average variable costs but below its average total costs of production, the firm will temporarily shut down.

F the firm will continue to operate in the short run as long as price exceeds average variable costs.

The only requirement for a market to be perfectly competitive is for the market to have many buyers and sellers.

F the goods offered for sale are largely the same and (possibly) firms can freely enter or exit the market.

The short-run market supply curve is more elastic than the long-run market supply curve.

F the long-run market supply curve is more elastic than the short-run market supply curve.

In the long run, perfectly competitive firms earn small but positive economic profits

F they earn zero economic profits in the long run.

Which of the following is not a characteristic of a competitive market? Answer There are many buyers and sellers in the market. The goods offered for sale are largely the same. Firms can freely enter or exit the market. Firms generate small but positive economic profits in the long run. All of the above are characteristics of a competitive market.

Firms generate small but positive economic profits in the long run.

You walk into a Walmart store at 2:00 a.m. with a friend to buy some USB flash drives. Your friend says, "I can't believe that these stores stay open all night. Only one out of fifteen checkout lines is open. There can't be more than ten shoppers in this store. It just doesn't make any sense for this store to be open all night." Explain to your friend what conditions must be true for it to be to the advantage of Walmart to stay open all night.

For Walmart to stay open all night (and not undertake a temporary shutdown), it must be true that its total revenue at night must equal or exceed its variable costs incurred from staying open the additional hours (electricity, wages of night shift workers, etc.).

If a firm is producing a level of output where marginal revenue exceeds marginal cost, would it improve profits by increasing output, decreasing output, or keeping output unchanged? Why?

If MR > MC, increasing output will increase profits because an additional unit of production increases revenue more than it increases costs.

If Walmart had the same number of customers during its daytime hours as you observed during its nighttime hours, do you think it would continue to operate? Explain.

It is unlikely. This is because the temporary shutdown decision (staying open additional hours at night) depends on whether total revenue equals or exceeds variable costs, but the decision to remain in the market in the long-run depends on whether total revenue equals or exceeds total costs. It is unlikely that the revenue earned at night covers total costs (both fixed and variable costs).

Suppose the price for a firm's output is above the average variable cost of production but below the average total cost of production. Will the firm shut down in the short run? Explain. Will the firm exit the market in the long run? Explain.

No. In the short run, the firm's fixed costs are sunk costs so the firm will not shut down because it only needs to cover its variable costs. Yes. In the long run, the firm must cover total costs, and if P < ATC, the firm generates losses in the long run and it will exit the market.

Are the costs of rent, equipment, fixtures, salaries of management, and so on relevant when Walmart makes the decision whether to stay open all night? Why or why not?

No. These costs are fixed costs or sunk costs—costs that cannot be recovered even if Walmart chooses not to operate at night.

A firm maximizes profit when it produces output up to the point where marginal cost equals marginal revenue. Answer

T

For a competitive firm, marginal revenue equals the price of the good it sells.

T

If a competitive firm sells three times the amount of output, its total revenue also increases by a factor of three.

T

If the price of a good rises above the minimum average total cost of production, positive economic profits will cause new firms to enter the market, which drives the price back down to the minimum average total cost of production.

T

In a competitive market, both buyers and sellers are price takers.

T

If a firm is in a competitive market, what happens to its total revenue if it doubles its output? Why?

Total revenue doubles. This is because, in a competitive market, the price is unaffected by the amount sold by any individual firm.

You go to your campus bookstore and see a coffee mug emblazoned with your university's shield. It costs $5, and you value it at $8, so you buy it. On the way to your car, you drop it, and it breaks into pieces. Should you buy another one or should you go home because the total expenditure of $10 now exceeds the $8 value that you place on it? Why?

You should buy another mug because the marginal benefit ($8) still exceeds the marginal cost ($5). The broken mug is a sunk cost and is not recoverable. Therefore, it is irrelevant.

In long-run equilibrium in a competitive market, firms are operating at Answer the minimum of their average-total-cost curves. the intersection of marginal cost and marginal revenue. their efficient scale. zero economic profit. all of the above.

all of the above.

If the long-run market supply curve for a good is perfectly elastic, an increase in the demand for that good will, in the long run, cause Answer an increase in the price of the good and an increase in the number of firms in the market. an increase in the price of the good but no increase in the number of firms in the market. an increase in the number of firms in the market but no increase in the price of the good. no impact on either the price of the good or the number of firms in the market.

an increase in the number of firms in the market but no increase in the price of the good.

In the long run, some firms will exit the market if the price of the good offered for sale is less than Answer marginal revenue. marginal cost. average revenue. average total cost.

average total cost.

If a competitive firm doubles its output, its total revenue Answer more than doubles. doubles. less than doubles. cannot be determined because the price of the good may rise or fall.

doubles.

For a competitive firm, marginal revenue is Answer equal to the price of the good sold. average revenue divided by the quantity sold. total revenue divided by the price. equal to the quantity of the good sold.

equal to the price of the good sold.

If a competitive firm is producing a level of output where marginal revenue exceeds marginal cost, the firm could increase profits if it Answer increased production. decreased production. maintained production at the current level. temporarily shut down.

increased production.

The long-run market supply curve Answer is always more elastic than the short-run market supply curve. is always less elastic than the short-run market supply curve. has the same elasticity as the short-run market supply curve. is always perfectly elastic.

is always more elastic than the short-run market supply curve

The competitive firm maximizes profit when it produces output up to the point where Answer marginal cost equals total revenue. marginal revenue equals average revenue. marginal cost equals marginal revenue. price equals average variable cost.

marginal cost equals marginal revenue.

If all firms in a market have identical cost structures and if inputs used in the production of the good in that market are readily available, then the long-run market supply curve for that good should be Answer perfectly elastic. downward sloping. upward sloping. perfectly inelastic.

perfectly elastic.

In the long run, the competitive firm's supply curve is the Answer entire marginal-cost curve. portion of the marginal-cost curve that lies above the average-total-cost curve. portion of the marginal-cost curve that lies above the average-variable-cost curve. upward-sloping portion of the average-total-cost curve. upward-sloping portion of the average-variable-cost curve.

portion of the marginal-cost curve that lies above the average-total-cost curve.

In the short run, the competitive firm's supply curve is the Answer entire marginal-cost curve. portion of the marginal-cost curve that lies above the average-total-cost curve. portion of the marginal-cost curve that lies above the average-variable-cost curve. upward-sloping portion of the average-total-cost curve. upward-sloping portion of the average-variable-cost curve.

portion of the marginal-cost curve that lies above the average-variable-cost curve.

If an input necessary for production is in limited supply so that an expansion of the industry raises costs for all existing firms in the market, then the long-run market supply curve for a good could be Answer perfectly elastic. downward sloping. upward sloping. perfectly inelastic.

upward sloping.

A grocery store should close at night if the Answer total costs of staying open are greater than the total revenue due to staying open. total costs of staying open are less than the total revenue due to staying open. variable costs of staying open are greater than the total revenue due to staying open. variable costs of staying open are less than the total revenue due to staying open.

variable costs of staying open are greater than the total revenue due to staying open.