ch 9 multiple choice
Economic Profit =
(Price - Average cost) × (Quantity Produced).
The market reaches equilibrium in the short run when two conditions are met:
a. The quantity of output supplied equals the quantity of output demanded. b. Each firm in the market maximizes its profit, given the market price.
The steepness of the slope is determined by the rate of
cost change.
Decreases in demand cause a rapid
decrease in price followed by a rise in price as firms exit the industry in the long run
Choose the level at which the marginal benefit
equals the marginal cost.
A firm should continue to produce as long as total revenue is
greater than operating cost, or price > average variable cost.
A perfectly competitive market is a market with many sellers and buyers of a
homogeneous product and no barriers to entry.
The Long-Run Supply Curve for an Increasing-Cost Industry 1. In the long run, a firm will only produce
if it can at least make zero economic profit.
Marginal revenue is the
increase in revenue from selling one more unit.
The short-run market supply curve
is a curve that shows the relationship between the market price and the quantity supplied by firms as a whole in the short run. It is the horizontal sum of the individual firm supply curves.
The market is said to be in long-run equilibrium when there is
no incentive for any firm to enter or exit the market; this occurs when economic profit equals zero
the long-run price in a
perfectly competitive industry must be equal to average cost.
Total revenue is the money that the firm
receives from selling its products
The cost of the facility is a
sunk cost
Short-run supplies will be steeper than long-run curves due to
the inability to adjust all factors of production in the short run.
The firm's short-run supply curve shows the relationship between
the market price of a product and the quantity of output supplied by a firm in the short run.
Shut down if
total revenue < variable cost.
A firm's operating cost is the cost incurred by operating (rather than shutting down). a. This is equivalent to variable cost. 3. The decision making rule is:
Operate if total revenue > variable cost.
There are four basic market structures discussed in this book
Perfect Competition—many firms, homogeneous product 2. Monopoly—single firm, unique product 3. Monopolistic Competition—many firms, differentiated product 4. Oligopoly—few firms, homogeneous or differentiated product
sunk cost
a cost that the firm has already paid or committed to pay, so it cannot be recovered (often the same as fixed cost). Thus, if the firm produces nothing, it will have a loss equal to the amount of fixed costs. If the firm operates, it will receive some revenues; as long as revenues exceed operating costs, the firm is better off
Short-run market supply can be found by summing supply curves of
all firms in the industry
The total cost is the sum of
all variable costs and fixed costs.
Increase the level of an activity as long as its marginal benefit
exceeds its marginal cost.
Even if you are losing money, at least you can pay some of the
fixed costs that will be paid in full if you shut down.
Thus the long-run supply curve, which represents long-run equilibrium points, is derived from
long-run industry break-even points.
The marginal principle requires that the firm produce the quantity at which
marginal revenue equals marginal cost.
For a perfectly competitive firm,
marginal revenue is equal to the price of the good because the firm is a price taker.
Total revenue equals price
multiplied by quantity sold.
The firm-specific demand curve is a curve showing the relationship between the
price charged by a specific firm and quantity the firm can sell.
An economic profit of zero means that
revenues just cover all costs, including opportunity costs. At this point, the price is defined as the break-even price.
The long-run supply curve is defined as a curve
showing the relationship between the market price and quantity supplied in the long run.
The profit-maximizing level of output can be found by
subtracting the total cost from the total revenue at each level of output and finding the output with the highest level of profit.
A price taker is a buyer or seller that
takes the market price as given.
Accounting profit equals
total revenue minus explicit costs.
Computing profit:
total revenue minus total economic cost.
An increasing-cost industry is one in which the average cost of production
increases as the total output of the industry increases.
The firm's shut-down price is defined as the price at which the firm
indifferent between operating and shutting down, P = MC = AVC. The shut-down price is equal to the minimum average variable cos
The marginal principle suggests that the firm should
pick the level of output at which marginal revenue = marginal cost.
For a perfectly competitive firm, this is equivalent to
price = marginal cost.
Firms losing money will continue to operate in the short run as long as
price exceeds average variable cost because then total revenues exceed operating costs and the loss is minimized.Thus the short-run supply curve of the firm is the marginal cost curve above the shut-down price.
increases in demand cause a rapid increase in
price followed by a fall in price as more firms enter the industry in the long run
in constant-cost industries,
they will be horizontal.
A firm should shut down if
total revenue is less than operating cost, or price < average variable cost.
Economic profit equals
total revenue minus total economic cost.
In increasing-cost industries, long-run supply curves will be
upward sloping
If profits exceed
zero in the long run, firms will enter and drive the price down.
1. Which of the following is NOT a characteristic of a perfectly competitive market? a. a large number of firms in a market. b. selling a standardized product. c. substantial barriers to entry. d. an individual firm has no control over price.
1. C If there are barriers to entry firms will not be able to enter the market the existing firms can charge a higher than efficient price. Requiring a license for barbers is a barrier to entry. It means that barbers can charge a higher price than would occur if anyone could cut hair. Why else do we need to have our barbers licensed. Check out littp://uww.state.ma.us/reg/boards/br/default.~~tm Maybe it's done just to keep the Barber Board employed - they collected $29,106 in fees in Massachusetts in 1998.
There are five features of a perfectly competitive market:
1. Many sellers (large number of firms) 2. Many buyers 3. Homogeneous product (standardized product) 4. No barriers to market entry 5. Buyers and sellers both take the market price as given
10. Refer to Figure 9.1. At a price of $75, the profit maximizing level of output is a. 0 b. 50 c. 100 d. 150
10. A Shut down - they cannot even cover their variable costs.
11. A firm will not shut down in the short-run as long as: a. price exceeds average fixed cost at the level of output where marginal revenue equals marginal cost. b. price exceeds average variable cost at the level of output where marginal revenue equals marginal cost. c. price exceeds marginal cost at the level of output where marginal revenue equals marginal cost. d. price exceeds total revenue at the level of output where marginal revenue equals marginal.
11. B
12. Suppose Tim's Cowboy boot factory produces in a perfectly competitive market. Suppose the average total cost of cowboy boots is $65, the average variable cost of cowboy boots is $60, and the price of cowboy boots is $62. If the firm is producing the level of output where marginal cost equals price, then in the short-run: a. the firm should shut-down. b. the firm should continue to produce since total revenue exceeds total variable cost. c. the firm is earning a positive economic profit. d. the firm can increase profit by increasing output.
12. B They are covering variable cost so continue to operate and use the revenue to defray some of your fixed costs. In the long run, of course, if nothing changed this firm would shut down.
13. Your firm is producing a good in a perfectly competitive market. If you know that when you produce 300 units per day, your total costs are $7000 and when you produce 301 units your total costs are $7001, then: a. you are maximizing profits if the price of the good is $5. b. you will be able to increase firm profits by decreasing output if the market price of your good is $5. c. you will be able to increase firm profits by increasing output if the market price of your good is $5. d. your average costs are increasing.
13.C MC is $1 (the difference in cost when you produced one more unit),price is $5, since P>MC you gain more than you lose by increasing production.
14. Your firm is producing a good in a perfectly competitive market. If you know that when you produce 250 units per day, your total costs are $1000 and when you produce 251 units your total costs are $1010, then if the market price of your good is $5: a. there is not enough information to determine whether you should increase production or decrease production. b. you will be able to increase firm profits by decreasing output. c. you will be able to increase firm profits by increasing output d. your average costs are decreasing.
14 B Because MC > P.
15. The supply curve for a perfectly competitive market: a. is the summation of all the average cost curves of each firm in a market. b. is the summation of all the marginal cost curves, above the minimum of the average variable cost curve, from all the individual firms in the market. c. is not related to the supply curves of individual firms. d. is independent of price.
15. B In order to get the market supply curve we simply add up all the individual supply curves.
16. If the market demand increases for a good sold in a perfectly competitive market, individual firms in the market: a. will be able to charge a higher price for their product. b. will need to lower price in order to remain competitive. c. will not be able to change their price. d. will begin earning economic losses.
16. A If the demand curve shifts out the new equilibrium price will be higher.
17. A perfectly competitive industry is in long-run equilibrium. If demand for the product increases, we can expect the price of the good to a. rise at first and then fall. b. fall at first and then rise. c. rise and remain at the higher price. d. fall and remain at the lower price.
17. A The increase in demand causes price to rise. If the firms were originally in equilibrium they were earning zero profit. Now that the p~ice has increased they will be earning positive economic profit. A key assumption in a perfectly conlpetitive market is that there is free entry and exit from the industry. Other people, seeing the economic profit being earned in this industry, will enter it. As more suppliers enter the market, supply shifts out. But as supply shifts out market price is driven down. The
18. Long-run equilibrium for a perfectly competitive industry occurs when a. P = MC = ATC b. P = MC = AVC c. P = MC = AFC d. P > MC = ATC
18. A
19. You notice that the price of butter rises and then falls. The best explanation for this is that a. demand for butter increased causing price to rise which attracted other firms to enter the market causing supply to increase which caused the price to go back down. b. demand for butter decreased causing price to rise which attracted other firms to enter the market causing supply to increase which caused the price to go back down. c. demand for butter increased causing price to rise which induced other firms to exit the market causing supply to decrease which caused the price to go back down. d. demand for butter increased causing price to rise which attracted other firms to enter the market causing supply to decrease which caused the price to go back down.
19. A
2. Firms in a perfectly competitive market: a. sell a differentiated product. b. sell homogeneous products, like wheat or corn. c. usually have large advertising budgets. d. try to attract customers away from their competitors.
2. B The idea here is create a perfectly efficient market. Obviously that doesn't really exist - even producing wheat has substantial barriers to entiy (you can't simply go out and become a farmer tomorrow) - but we want to study the most efficient of all possible markets before we study the others. We focus on this pcrfect market then start relaxing some the assumption that crated it and see how much less efficient it is. Ideally all markets would be perfectly competitive but it turns out that they are not. The government, at least in principle, tries to take action to be as close to the perfect,ly competitive outcome as possible. This is why the Dept. of Justice keeps busting Microsoft's chops, at least that's what th government would say. Starting with chapter 13, we -will look at markets that are not perfect.
20. Explain why perfectly competitive firms make zero economic profit in the long-run.
20. Firms earn zero profit because they must accept the market price without having any influence over it, and other firms may freely enter the market. If profits are being earned firms will ent,er and drive the price down. If firms are earning a loss they will leave the industry and the price .;-ill rise ant.il no one is losing money. The firms may be able to increase their profits by expanding the scale of their operation. So in the long run equilibrium, firms will be at the minimum of their long run average cost curve. Recall that the market is large enough relative to the firms to obsorb any output firms are wdling to supply at the market price. In the case where a firms LRAC curve is downward slop ing over the entire range where demand exists, the industry will tend towards mnonopoly.
3. A perfectly competitive firm can: a. affect the market price for its good. b. sell as much as it can produce at the market price. c. prevent entry of other firms into their market. d. collude with its competitors to set prices.
3. B Because it is smdl relative to the market.
4. Because individual firms cannot affect the market price of their good, for each firm in a competitive market: a. price exceeds marginal revenue. b. total revenue increases by more than the market price when an additional unit is sold. c. price is equal to marginal revenue. d. price is less than marginal revenue.
4. C An individual firm can charge any price it wants but if it charges a price higher than the market price no one would buy their product. Demand would fall to zero for them. They would be stupid to drop their price beneath the market because they can sell all they want at the market price. Normally we would write the quanitity demanded as a function of the price (as it is for the market) like Q(P) = 200 - 3P. The suppliers would probably invert this equation because they want to laow how high of a price they can charge and still sell enough goods to make money. So they \vould look at an inverse demand curve P(Q) = - 4Q. This is the situation in the first frame of Eigure 9.5. For the individual firm though, P(Q) = 12. It is constant , so P really isn't a function of Q. Price does not vary with output so the demand curve for a firm is flat. Marginal revenue is the change in total revenue for a one unit increase in quantity. In the case of the individual firm, MR = ATR(Tota1 revenue) = P(Q + 1) - PQ = PQ + P - PQ = P. So for an individual firm the demand curve is a horizontal line at whatever the price is. For a monopoly, the market demand curve is their demand curve since they serve the entire market. For them Q is a function of P. So for them total revenue is P(Q)Q. Now marginal revenue is P(Q+l)(Q+l) - PQ = YQ - 1 (Q + 1) Q + 200 - gQ - (y - 4Q)Q = - $Q. It turns out that if the demand curve is linear the marginal revenue curve to the monopolist is twice as steep.
5. Farmer Brown sells her wheat in a perfectly competitive market. Suppose the current market price of wheat is $2.50 per bushel. If farmer Brown charges $2.51 for her wheat, a. farmer Brown will sell slightly less wheat than her neighbors, but will still make a substantial profit. b. farmer Brown will have to plant more acres of wheat to maximize her profit. c. farmer Brown will sell no bushels of wheat. d. farmer Brown will increase her total revenue
5. C Again demand is perfectly elastic to Farmer Brown.
6. Refer to Figure 9.1. The good is sold in a perfectly competitive market. If the market price of the good is $150, the profit maximizing level of output is: a. 0 b. 100 c. 200 d. 250
6. C The profit maximizing level of output is always whereever MR = MC. In this case P = MR, so the profit maximizing level of output, where P = MC is 200 units. This is worth some thought. If MR > MC then I am gaining more by supplying the good than it cost me to produce it - so I would increase my profits by increasing production. if MR < MC then I am gaining less by supplying the unit than it cost me to produce - so I would decrease my profits by producing more - in fact I should cut production. Don't confuse the MR = MC condition with TR and TC. MR and MC are the CHANGES in revenue and costs, not the total revenues and costs. Consider this. Last night a friend told me I should fly east in May and meet him at a big party in Damascus, Va. I've been to the party before and it's a lot of fun but there is no way I can afford it ... or is there? The MC to the airline must be fairly low. I mean planes are flying 1/3 empty right now. What does it cost them to fill one of those; empty seats? The cost of a bag of peanuts, a little extra work for the luggage handlers and maybe a slight increase in insurance premiums, etc ... The bottom line is that the airline would increase profits (or at least lose less money) if I offered them more than the cost of flying me. Since the seat would be empty anyway there is basically no opportunity cost to them. This is why you can get really cheap airline tickets by flying stand by. So forget about all this school stuff and go on vamtion.
7. Refer to Figure 9.1. The good is sold in a perfectly competitive market. If the market price of the good is $150 at the profit maximizing level of output, total profit is: a. $0. b. $4,000 c. $5,000 d. $30,000
7. Total profit is TC - TR. ... There are a couple of ways of calculating this. First, TR is PQ, which the area of the rectangle with length 200 and height 150, or 30,000. Now, we don't know TC, but notice that ATC = $f , we know ATC afid Q so TC = QxATC = 200x 130 = 26,000. So profits are 30,000 - 26,000 = 4,000. Another way to do this, a. simpler way, is to w~ite i7 = TR - TC = PxQ - PxATC = Px (Q - ATC). This is the area of the rectangle with length 200 and height 150 - 130 = 20. So i7 = 20x200 = 4,000. i7 is a commonly used symbol for profits.
8. Refer to Figure 9.1. The firm's short-run supply curve is a. the marginal cost curve above $150. b. the marginal cost curve above $125. c. the marginal cost curve above $100. d. the marginal cost curve above $75.
8. C Since we know that a profit maximizing firm wil always choose the quantity where P = MC, and since MC is a function of Q, we can w~ite Q as a function of P. That is, for any price, the position of the MC curve tells us how much we should produce. This is the firm's supply curve, at least at prices above 100. Slippose the price was 110, then the fimr would be losing money, but if they shut down they would still be losing money because in the short run they still must pay their fixed costs. Since 110 > 100 we know that the firm can produce the Q where P = MC and cover their variable cost. Whatever is left over can then be used to pay down part of their fixed cats. So as long as P > AVC the firm should chome the Q where P = MC. Lf the P < AVC, the firm could not even cover there variable cost, so they should shut down. So the firm's supply curve is their MC curve where it lies above AVC
9. Refer to Figure 9.1. Total fixed cost is a. $4,000 b. $22,000 c. $26,000 d. not enough information to determine.
9. A This is a tricky one. Recall from the last chapt,er that ATC = AFC + AVC, so AFC = ATC - AVC. At Q = 200 we know that AVC = 110 and ATC = 130. So, AFC = 130 - 110 = 20. Now AFC = %==> FC = QxAFC = 200x20 = 4000.
The market reaches equilibrium in the long run when the above two conditions are met as well as:
Each firm in the market earns zero economic profit, so there is no incentive for other firms to enter (or exit) the market. (Make sure students connect the two curves.)
