Chapter 12 Microeconomics
Does the market system result in allocative efficiency? In the long run, perfect competition A. does not result in allocative efficiency because price does not equal the marginal benefit consumers receive from consuming the last unit of the good sold. B. results in allocative efficiency because firms produce where price equals marginal cost. C. does not result in allocative efficiency because firms enter and exit until they break even where price equals minimum average cost. D. does not result in allocative efficiency because firms produce an identical product that offers consumers no variety. E. results in allocative efficiency because firms produce where the marginal benefit consumers receive from consuming the last unit of the good sold is greater than marginal cost.
B
Does the market system result in productive efficiency? In the long run, perfect competition A. results in productive efficiency because production represents consumer preferences. B. does not result in productive efficiency because barriers to entry result in firms making a profit. C. results in productive efficiency because firms enter and exit until they break even where price equals minimum average cost. D. does not result in productive efficiency because price-taking firms produce where price equals marginal cost. E. results in productive efficiency because every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.
C
What is a price taker? A price taker is A. a firm that has the ability to charge a price greater than marginal cost. B. a firm that does not seek to maximize profits. C. a firm that is unable to affect the market price. D. a firm with a downward-sloping demand curve. E. a firm with a perfectly inelastic demand curve.
C
The first market structure we will examine is the perfectly competitive market: one in which
There are many buyers and sellers,•All firms sell identical products, and•There are no barriers to new firms entering the market.
The firm's shutdown decision is based on its variable costs; it should produce nothing only if:
Total Revenue < Variable Cost (PxQ) < VC P<AVC
Industries where the production process is infinitely replicable—_____________—are modeled well by this horizontal supply curve.
constant cost industries
Profit=
(PxQ)-TCProfit=(P-ATC)xQ
The rules we have just developed for profit maximization are:
1. The profit-maximizing level of output is where the difference between total revenue and total cost is greatest, and 2.The profit-maximizing level of output is also where MR = MC.(Only for perfect competitive markets): The profit-maximizing level of output is also where P = MC.
Industries where the production process is infinitely replicable—constant cost industries—are modeled well by this horizontal supply curve. But what if this is not the case?
1.If some factor of production cannot be replicated, additional firms may have higher costs of production. 2. On the other hand, sometimes additional firms might generate benefits for other firms in the market, leading additional firms to have lower costs of production.
We have shown that in the long run, perfectly competitive markets are productively efficient. But they are allocatively efficient also:
1.The price of a good represents the marginal benefit consumers receive from consuming the last unit of the good sold. 2.Perfectly competitive firms produce up to the point where the price of the good equals the marginal cost of producing the good.3.Therefore, firms produce up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.
Assume the market for oranges is perfectly competitive. If the demand for oranges increases, will the market supply additional oranges? If the demand for oranges increases, then the market A. will supply additional oranges because producers seek the highest return on their investments. B. will not supply additional oranges because government bureaucrats will not order additional orange production. C. will supply additional oranges because producers are price takers. D. will not supply additional oranges because oranges produced by different sellers are identical. E. will not supply additional oranges because consumers are not willing to pay higher prices for fruit.
A
How should firms in perfectly competitive marketsLOADING... decide how much to produce? Perfectly competitive firms should produce the quantity where A. the difference between total revenue and total cost is as large as possible. B. their individual price is as high as possible. C. their individual price is equal to the market price. D. the difference between explicit costs and implicit costs is as large as possible. E. the market price is as high as possible.
A
Suppose the market for cotton is perfectly competitive and that input prices increase as the industry expands. Characterize the industry's long-run supply curve. The cotton industry's long-run supply curve will be A. upward sloping because the long-run average cost of production will be increasing. B. downward sloping because the total cost of production will be increasing. C. downward sloping because existing firms will exit as they experience losses. D. upward sloping because new firms will enter as prices rise. E. horizontal and equal to the minimum point on the long-run average cost curve.
A
When are firms likely to be price takers? A firm is likely to be a price taker when A. it sells a product that is exactly the same as every other firm. B. barriers to entry are substantial. C. firms in the industry collude. D. it represents a substantial portion of the total market. E. it has market power.
A
Why are consumers so powerful in a market system? A. Because it is consumers' demand that influences the market price and dictates what producers will supply in the market. B. Because there are more consumers than producers. C. Because consumers can lobby the government to impose regulations on the businesses. D. Because consumer surplus is larger than producer surplus.
A
The firm's marginal cost curve is its supply curve only for prices at or above
AVC
is a state of the economy in which production is in accordance with consumer preferences; in particular, every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.
Allocative efficiency
Does the market system result in productive efficiency? In the long run, perfect competition A. results in productive efficiency because production represents consumer preferences. B. results in productive efficiency because firms enter and exit until they break even where price equals minimum average cost. C. does not result in productive efficiency because price-taking firms produce where price equals marginal cost. D. does not result in productive efficiency because barriers to entry result in firms making a profit. E. results in productive efficiency because every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.
B
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 A. firms have market power. B. firms can sell as much output as they want at the market price. C. firms are price makers. D. there are barriers to entry. E. firms face downward sloping demand curves.
B
What are the three conditions for a market to be perfectly competitive? For a market to be perfectly competitive, there must be A. many buyers and a small number of firms that compete, selling identical products, and barriers to new firms entering the market. B. many buyers and sellers, with all firms selling identical products, and no barriers to new firms entering the market. C. many buyers and a few sellers, with all firms selling identical products, and no barriers to new firms entering the market. D. many buyers and sellers, with firms selling similar but not identical products, with low barriers to new firms entering the market. E. many buyers and one seller, with the firm producing a product that has no close substitutes, and barriers to new firms entering the market.
B
When are firms likely to enter an industry? When are they likely to exit? A. Accounting profits attract firms to enter an industry, and accounting losses cause firms to exit an industry. B. Economic profits attract firms to enter an industry, and economic losses cause firms to exit an industry. C. Firms will exit an industry when price is greater than the minimum point on the average total cost curve, and firms will enter an industry when price is less than the minimum point on the average total cost curve. D. Firms will enter an industry when price equals marginal cost, but firms will exit an industry when price does not equal marginal cost. E. Firms will exit an industry when price is less than the minimum point on the average variable cost curve, and firms will enter an industry when price is greater than the minimum point on the average variable cost curve.
B
Why are firms willing to accept losses in the short run but not in the long run? A. Firms cannot shut down in the short run. B. There are fixed costs in the short run but not in the long run. C. Firms are price takers in the short run but not in the long run. D. It is always profitable to incur losses in the short run because profits will always arise in the long run. E. Sunk costs are larger in the long run than in the short run.
B
What conditions make a market perfectly competitive? A market is perfectly competitive if A. it has many buyers and one firm, which produces a product with no close substitutes, with barriers to new firms entering the market. B. it has many buyers and a few sellers, all of whom are selling differentiated products, with no barriers to new firms entering the market. C. it has many buyers and many sellers, all of whom are selling differentiated products, with no barriers to new firms entering the market. D. it has many buyers and many sellers, all of whom are selling identical products, with no barriers to new firms entering the market. E. it has many buyers and a few sellers, all of whom are selling identical products, with barriers to new firms entering the market.
D
What determines entry and exit of firms in a perfectly competitive industry in the long run? In a perfectly competitive industry in the long run, A. new firms will enter if price is above the shutdown point and existing firms will exit if price is below the shutdown point. B. new firms cannot enter the market due to barriers but existing firms will exit if they are experiencing losses. C. new firms will enter if existing firms are making a profit and existing firms will exit if they are breaking even or experiencing losses. D. new firms will enter if existing firms are making a profit and existing firms will exit if they are experiencing losses. E. new firms will enter if market demand exceeds market supply and existing firms will exit if market supply exceeds market demand.
D
Which of the following is an expression of profit for a perfectly competitive firm? Profit for a perfectly competitive firm can be expressed as A. Profit=P−ATC, where P is price and ATC is average total cost. B. Profit=P×Q, where P is price and Q is output. C. Profit=P−MC, where P is price and MC is marginal cost. D. Profit=(P−ATC)×Q, where P is price, Q is output, and ATC is average total cost. E. Profit=(P×Q)−(TC×Q), where P is price, Q is output, and TC is total cost.
D
Suppose the market for cotton is perfectly competitive and that input prices decrease as the industry expands. Characterize the industry's long-run supply curve. The cotton industry's long-run supply curve will be A. upward sloping because new firms will enter as prices rise. B. horizontal and equal to the minimum point on the long-run average cost curve. C. upward sloping because the total cost of production will be decreasing. D. downward sloping because existing firms will exit as they experience losses. E. downward sloping because the long-run average cost of production will be decreasing.
E
What is the difference between a firm's shutdown point in the short run and its exit point in the long run? In the short run, a firm's shutdown point is the minimum point on the A. average variable cost curve, while in the long run, a firm cannot exit. B. average variable cost curve, while in the long run, a firm's exit point is the minimum point on the average fixed cost curve. C. average total cost curve and in the long run, a firm's exit point is the minimum point on the average total cost curve. D. marginal cost curve and and in the long run, a firm's exit point is the minimum point on the marginal cost curve. E. average variable cost curve, while in the long run, a firm's exit point is the minimum point on the average total cost curve.
E
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 A. that firm's marginal revenue curve. B. that firm's marginal cost curve for prices at or above average total cost. C. that firm's marginal revenue curve for prices at or above average variable cost. D. a horizontal line equal to the market price. E. that firm's marginal cost curve for prices at or above average variable cost.
E
So the marginal cost curve gives us the relationship between price and quantity supplied:
It is the firm's supply curve
The situation in which the entry and exit of firms has resulted in the typical firm breaking even.
Long-run competitive equilibrium
Market Structure Monopolistic Competition Number of firms: Type of product: Ease of entry: Examples of industries:
Market Structure Monopolistic Competition Number of firms: Many Type of product: differentiated Ease of entry: high Examples of industries: clothing stores and restaurants
Market Structure Monopoly Number of firms: Type of product: Ease of entry: Examples of industries:
Market Structure Monopoly Number of firms: one Type of product: unique Ease of entry: entry blocked Examples of industries: first-class mail delivery providing tap water
Market Structure Oligopoly Number of firms: Type of product: Ease of entry: Examples of industries:
Market Structure Oligopoly Number of firms: few Type of product: identical or differentiated Ease of entry: low Examples of industries: manufacturing computers and manufacturing automobiles
Market Structure Perfect Competition: Number of firms: Type of product: Ease of entry: Examples of industries:
Market Structure Perfect Competition: Number of firms: Many Type of product: Identical Ease of entry: high Examples of industries: Growing wheat and poultry farming
For a firm in a perfectly competitive market, price is equal to both average revenue and marginal revenue:
P=TR/Q=Change in TR/Change Q
Revenue for a perfectly competitive firm is easy: the firm receives the same amount of money for every unit of output it sells. So
Price = average revenue= marginal revenue
Things about the long-run supply curve
So the long-run supply curve is horizontal at this price. •In a perfectly competitive market, the long-run price is completely determined by the forces of supply. •The number of suppliers adjusts to meet demand, at the lowest possible price.
How can we illustrate profit on a graph=
The right hand side is the area of a rectangle with height (P −ATC) and length Q.
is total revenue divided by the quantity of the product sold
average revenue
A curve that shows the relationship in the long run between market price and the quantity supplied.
long-run supply curve
So the firm supplies output according to its
marginal cost curve
is the change in total revenue from selling one more unit of a product.
marginal revenue
By definition, a perfectly competitive firm is too small to affect the
market price
models of how the firms in a market interact with buyers to sell their output.
market structures
The first and second conditions imply that perfectly competitive firms are
price takers
buyers or sellers that are unable to affect the market price. This is because they are tiny relative to the market and sell exactly the same product as everyone else
price takers
is a situation in which a good or service is produced at the lowest possible cost.
productive efficiency
What are two types of efficiency?
productive efficiency and allocative efficiency
The difference between price and average total cost equals
profit per unit of output.
Where marginal revenue equals marginal cost
profit-maximizing level of output
The previous slides have described how long-run competitive equilibriumis achieved in a perfectly competitive market:
•If firms are making an economic profit, additional firms enter the market, driving down price to the break-even level. •If firms are making an economic loss, existing firms exit the market, driving price up to the break-even level.
The market structures we will examine are, in decreasing order of competitiveness:
•Perfectly competitive markets •Monopolistically competitive markets •Oligopolies •Monopolies.
