Chapter 6 Test
1) Use Figure 6.5 to determine (a) How many baskets of fish should be harvested at market prices of (i) $9 (ii) $13 (iii) $17 (b) How much total revenue is collected at each price? (c) How much profit does the farmer make at each of these prices?
(a) (i) A competitive firm maximizes total profits at the output rate where MC = P. In this case, when P = $9, the output rate where MC($9) = P($9) is 3 baskets of fish. (ii) When P = $13, the output rate where MC($13) = P($13) is 4 baskets of fish. (iii) When P = $17, the output rate where MC($17) = P($17) is 5 baskets of fish. (b) (i) Total revenue is equal to P × Q. In this case, when price is $9 and quantity is 3, total revenue is $27 (= $9 × 3). (ii) When price is $13 and quantity is 4, total revenue is $52 (= $13 × 4). (iii) When price is $17 and quantity is 5, total revenue is $85 (= $17 × 5). (c) (i) Profit is equal to total revenue minus total cost. In this case, when price is $9, total revenue is $27 and total cost (to produce 3 baskets as given in the cost table) is $31. Therefore, profit is $-4 (= $27 - $31). (ii) When price is $13, total revenue is $52 and total cost (to produce 4 baskets as given in the cost table) is $44. Profit is $8 (= $52 - $44). (iii) When price is $17, total revenue is $85 and total cost (to produce 5 baskets as given in the cost table) is $61. Thus, profit is $24 (= $85 - $61).
What curve is shifting to alter the market equilibrium in the News Wire "Entry an Exit"?
(a) According to the article, at the market level there has been increased domestic production and increased imports. This represents an increase in the number of suppliers, causing the market supply to increase, driving the market price down. Individual catfish farmers in Belzoni have faced rising feed and electricity prices, causing their costs of production at the firm level to rise.
If the price of a catfish is 95 cents a pound and the market price of the fish is $1 a pound, should an existing farmer stop producing?
A catfish farmer should only stop producing if the price of catfish falls below average total costs. In this case, if the farmer's price is .95 cents, this will not make a difference, since the market price is $1 per pound. The farmer will still wind up receiving the market price for the fish, since the farmer's output is small relative to market supply such that the farmer's output has no significant effect on the total quantity or price in the market. If the market price is below the farmer's average total cost, then the farmer should stop producing.
Why doesn't a corn farmer have to make pricing decision?
A corn farmer does not have to make a pricing decision because the corn produced is identical to the corn produced by other similar farmers. The farmer faces a perfectly competitive market without product differentiation, and as a result, is a price taker - the price the farmer faces is the market price. The farmer's output is small relative to market supply such that the farmer's output has no significant effect on the total quantity or price in the market.
Graphically show the market outcome for a typical catfish farmer in Mississippi today as described by James Avery in the News Wire "Entry and Exit."
According to the article, the individual catfish farmers in Belzoni have faced rising feed and electricity prices, causing their costs of production at the firm level to rise. At the same time, the market price for fish has been falling due to higher overall production and increasing imports. The result is that the market price is less than the average total costs, causing the individual catfish farmer in Belzoni to earn economic losses.
Why would anyone want to enter a profitable industry knowing that profits would eventually be eliminated by competition?
Even though the economic profits are expected to be temporary and returns to resources in this industry will equal their next best alternative, the adjustment process may take a number of years. During the adjustment process, firms that enter the industry may earn substantial profits.
Adam Smith in the Wealth of Nations asserted that the pursuit of self-interest by competitive firms promoted the interests of society. What did he mean by this?
In attempting to obtain the highest return on resources, businesses will seek out markets with the greatest profit potential. Entering these industries shifts the supply curve to the right, lowering prices to the minimum point on the average total cost curve. Thus, the drive of profits results in consumers receiving products at the lowest possible cost, and producers are driven to make the most efficient use of available resources.
If there were more bookstores around your campus, would textbook prices rise or fall? Why aren't there more bookstores?
Prices would fall as supply increased. There may not be more bookstores for a variety of reasons. First, there might be high barriers to entry. For small schools, the college might refuse to give competition their book orders. It might also be the case that profits are not high enough to attract new firms into the market, i.e., only normal profits are being earned.
In the News Wire "Competitive Pressure," what types of costs are cited? Which are not mentioned? If the shop owner wanted to increase production and sales, what additional costs would he incur? Should he do so?
The owner is tabulating only the marginal costs of a T-shirt. He is saying nothing about the fixed costs of production (e.g., the store rent), which will also determine his profits. To increase production (sales), he would need not only more material, but also more labor, electricity, and other variable costs. He should do so only if price exceeds marginal costs (which appears to be the case here).
If Apple had no competitors, would it be improving iPhone features as fast?
Yes, Apple would continue to improve its products even without competitors since this creates higher barriers to entry for new firms trying to enter this market. In this case a higher technology barrier has been created for firms trying to compete with Apple.
What industries do you regard as being highly competitive?
Farming and farm supplies — Barriers are the cost of land and machinery or in the case of chemical applications, licensing. Consumer electronics - Barriers are brand loyalty or control of essential factors of production. Dry cleaners - Barriers are the availability of suitable locations (near residential areas and properly zoned) and the availability of equipment, in addition to high start-up costs. Internet Service Providers - Barriers are the knowledge of running a server, the cost of purchasing the computer server and the cost of a dedicated trunk line for access to the telephone network. Taxi service - Barriers include the need for taxi medallions, which must be purchased from existing companies or acquired through an expensive legal proceeding.
1) Graph a situation where the typical catfish farmer is incurring a loss at the prevailing market price P1 (a) What is MC equal to at the best possible rate of output? (b) Is ATC above or below P1? (c) Which of the following would raise the market price? A. A reduction in the firm's output B. An increase in the firm's input costs. C. Exits from the industry D. An improvement in technology (d) What price would prevail in long-run equilibrium?
(a) A competitive firm maximizes total profits at the output rate where MC = P. If MC is less than price, the firm can increase profits (or reduce losses) by producing more. If MC exceeds price, the firm should reduce output. In this case, profit maximization occurs at an output of 650 pounds of fish per day. Even when a firm is operating at a loss, this is the best possible rate of output. In this example of a typical catfish farmer, the profit-maximizing rate of output is where MC = P. Since price is $4, MC = $4. (b) ATC is above price and the firm is therefore operating at a loss. Specifically, ATC is about $5 and price is equal to $4. (c) Exits from the industry cause the market supply to shift to the left and therefore increase market price. Once entry and exit cease, the market price stabilizes. (d) In the long-run competitive market equilibrium, price equals minimum average total cost and economic profit is eliminated. In this case, a price of $5 would prevail in the long
1) Suppose a firm has the following costs: (LO 6-3) Output (units): 10 11 12 13 14 15 16 17 18 19 Total Cost: $50 $52 $56 $62 $70 $80 $92 $106 $122 $140 (a) If the prevailing market price is $14 per unit, how much should the firm produce? (b) How much profit will it earn at that output rate? (c) If it increases output by 2 units, will it make more profit or less?
(a) A competitive firm maximizes total profits at the output rate where MC = P. Remember from a previous chapter that marginal cost is the change in total cost when output is increased by one more unit [MC = (TC2 - TC1)/(Q2 - Q1)]. According to the table, this is at an output level of 17 units where MC equals P (MC = $106 - $92 = $14 and P = $14). (b) Profit is equal to total revenue minus total cost (Profit = TR - TC). Total revenue is price multiplied by quantity (TR = P × Q). At the profit-maximizing output level of 17 units, total revenue is $238 (= $14 × 17 units) and total costs are $106 (as given by the table). Thus profit is $132 (= $238 - $106). (c) The firm maximizes profits where marginal revenue equals price. If the firm increases output beyond the profit-maximizing output, profits will fall.
1) If feed prices were to rise (a) which curve in Figure 6.5 would be affected? (b) how would it change? (c) how would the profit-maximizing rate of output change?
(a) If feed prices rise, marginal cost would rise. Graphically, the marginal cost curve would shift up, representing this rise in feed prices. (b) If feed prices rise, marginal cost would rise. Graphically, the marginal cost curve would shift up, representing this rise in feed prices. (c) Recall that the profit-maximizing rate of output for a perfectly competitive firm is where marginal cost equals price. Since marginal cost rose, the intersection of the marginal cost curve with the price curve is to the left of the original equilibrium. In other words, this increase in marginal cost would cause a decrease in the profit-maximizing rate of output.
(a) What are the expected profits for a perfectly competitive firm in the long-run? (b) Create a graph that shows the firm's long run outcomes
(a) In long-run competitive market equilibrium, price equals minimum average total cost and economic profit is eliminated (economic profit = $0). Zero economic profit is shown graphically when the price line is equal to the minimum of the average total cost
9) Suppose that the monthly market demand schedule for Frisbees is (LO 6-5) Price $8 $7 $6 $5 $4 $3 $2 $1 Quantity Demanded 1,000 2,000 4,000 8,000 16,000 32,000 64,000 150,000 Suppose further that the marginal and average costs of Frisbee production for every competitive from are Rate of Output 100 200 300 400 500 600 Marginal cost $2.00 $3.00 $4.00 $5.00 $6.00 $7.00 Average total cost $2.00 $2.50 $3.00 $3.50 $4.00 $4.50 Finally assume that the equilibrium market price is $6 per Frisbee. (a) Draw the cost curves of the typical firm. (b) Draw the market demand curve and identify market equilibrium. (c) How many Frisbees are being sold in equilibrium? (d) How many (identical) firms are initially producing Frisbees? (e) How much profit is the typical firm making? In view of the profits being made, more firms will want to get into Frisbee production. In the long run, these new firms will shift the market supply curve to the right and push the price down to minimum average total cost, thereby eliminating profits. (f) At what equilibrium price are all profits eliminated? (g) How many firms will be producing Frisbees at this price?
(a) Marginal cost is provided in the table above. It is plotted with "marginal cost" on the vertical axis and "rate of output" on the horizontal axis. Average total cost is plotted in the same manner with "average total costs" on the vertical axis and "rate of output" on the horizontal axis. (b) Market demand is provided in the table above. It is plotted with "price" on the vertical axis and "quantity demanded" on the horizontal axis. According to the problem equilibrium market price for a Frisbee is $6, hence market equilibrium is 4,000 Frisbees at a price of $6. (c) Once again, at an equilibrium market price of $6 per Frisbees, 4,000 Frisbees are being sold. (d) If the market price is $6, then each individual profit-maximizing firm would produce an output of 500 units where MC = MR = P. Thus, there are 8 identical firms (= 4,000 / 500 units) selling Frisbees. (e) Profits of a typical firm are $1,000. Selling 500 Frisbees at $6 each generates total revenue of $3,000. The total cost of producing 500 Frisbees at $4 each is $2,000. (f) Profits will be eliminated when the long-run price equals the minimum ATC, $2 in this case. (g) At this price, 64,000 units are demanded and individual firms will produce only 100 units. Thus, there will be 640 firms in the industry in the long run.
1) In Figure 6.5, what rate of output (a) Maximizes total revenue? (b) Maximizes profit per unit? (c) Maximizes total profit? (Choose the higher level of output.)
(a) Total revenue is equal to price times quantity. According to the table, total revenue is maximized at 5 baskets of fish and a total revenue of $65. (b) Profit is total revenue minus total cost. Profit per unit is profit divided by output. Profit per unit is maximized at 3 baskets of fish or a profit per basket of $2.67 (= $8/3baskets). (c) Once again, total profit is total revenue minus total cost.Profit is maximized at both 3 and 4 baskets where total profit is $8.In this case you were asked to choose the higher level of output.
1) Consider the case of a T-shirt shop for which the following data apply: Rent = $ 200/day; Labor cost = $4/shirt; and Output (sales) = 40 T-shirts/day. Using these data and the information contained in the News Wire "Competitive Pressure" on page 130, compute: (LO 6-3) (a) Total revenue per day. (b) Average total cost. (c) Per unit profit. (d) Total profit per day.
(a) Total revenue is price times quantity (TR = P × Q). Price is given as $15 per shirt in the article and quantity (sales or output) is given in the table as 40 shirts per day. Therefore total revenue is equal to $600 per day (= $15 per shirt × 40 shirts per day). (b) Average total cost can be calculated two different ways. Either method yields the same result. The costs given in the News Wire and the table include blank shirts, stock transfers, labor cost per shirt, and rent per day. (i) Average total cost is total cost divided by total output (ATC = TC/output). The total costs include rent (per day) and total spending on blank shirts, stock transfers, and labor for the 40 shirts sold per day. Total cost = $200 + ($1.60 × 40 + $1.50 × 40 + $4.00 × 40) = $200 + $284 = $484. Average total cost = $12.10 (= total cost/output = $484/40). (ii) Average total cost is the summation of all per unit costs (ATC = cost1/output + cost2/output + ...) The costs per unit include rent (per shirt = $400/40 shirts = $10 per shirt) and spending on blank shirts, stock transfers, and labor cost per shirt. Average total cost = $12.10 (= $10.00 + $1.60 + $1.50 + $4.00). (c) Profit per unit is price minus average total cost (Profit per unit = P - ATC). Therefore, profit per unit is $2.90. (d) Total profit can be calculated two different ways. Either method yields the same result. (i) Total profit is the difference between total revenue and total cost (Total profit = TR - TC). Total revenue was calculated in (a) as $600 and total cost was calculated in (b) as $484. Therefore, total profit is $116 (= $600 - $484). (ii) Total profit is average profit times quantity sold (Total profit = average profit × quantity sold). Average profit is the same as profit per unit. Profit per unit was calculated in (c) as $2.90 per shirt and quantity sold was given in the table as 40 shirts per day. Therefore, total profit is $116 (= $2.90 per shirt × 40 shirts).
Why doesn't Coke lose all its customers when it raises its price? Why would a catfish farmer lose all her customers if she raised her price?
Because many customers are loyal to the Coke brand name, Coke can raise its price without losing all of its customers, many of whom consider it to be a unique product, i.e., one with no close substitutes, not even Pepsi. A catfish farmer will, however, lose all of his customers at a higher price because customers are not loyal to a specific farmer's catfish, which are not usually "branded." As a result, if one farmer raises the price, customers will switch to another farmer's catfish.
What is making life so difficult for the catfish farmers in Belzoni, Mississippi? (see the News Wire "Entry and Exit"). What can they do to make their lives better?
Catfish farmers in Belzoni, Mississippi, face increasing costs to feed for the fish and electricity, as well as increased competition from both domestic and foreign producers. Market prices for catfish have decreased since more firms have entered the market. Farmers have been exiting this market due to the challenge of covering average total costs. Farmers can improve their lives by finding ways to decrease costs to stay in business, accounting for the lower market price, or by exiting and moving into another industry where prices and profits are high enough to cover costs.
