ECON-2302 Inquizitive Ch. 9 - Firms in a Competitive Market
Relative to other market structures, perfectly competitive markets have which of the following properties?
Property of a Competitive Market ~Entering and exiting the market are relatively easy ~Firms produce similar or standardized products ~Firms are price takers, or they have no control over price Not a Property of a Competitive Market ~Firms have significant price control [Perfect competition firms are price takers] ~Firms are very large relative to the market [Perfect competition firms are small relative to the market] ~Firms produce differentiated products [Perfect competition involves standardized, homogenous, or similar products]
Calculate the economic profit of the tree-trimming firm whose explicit and implicit expenses are shown. Ms. Tree has a total revenue of $98,000. Ms. Tree's Economic Profit and the Entry or Exit Decision Explicit costs per year Payment on the loan on boom lift truck $12,000 Gasoline $4,000 Miscellaneous equipment $16,000 Implicit costs Earnings forgone by not working for Mr. Plow $45,000 The forgone income that the $50,000 invested in the boom lift truck could have earned if invested elsewhere $7,000
~$14,000 [The positive economic profit means Ms. Tree can continue operation, but it is also a signal to other firms to enter the market] *[98000 - (12000 + 4000 + 16000) - (45000 + 7000)]
Sharifa runs a profit-maximizing ice cream shop where she sells her famous chocolate-fudge banana sundaes. Sharifa has taken a microeconomics course, so she knows to produce at the optimal output. Based on the information shown in the graph, what is Sharifa's total profit?
~$250 [At 200, marginal revenue (MR) = marginal cost (MC); total revenue (TR) = $5 × 200 and total cost (TC) = $3.75 × 200, so ($1,000 - $750 = $250)]
Use the figure to calculate the maximum possible profit for the firm whose marginal revenue (MR), marginal cost (MC), and average total cost (ATC) are functions of production quantity Q as shown.
~$480 [The profit-maximizing quantity (80) occurs where MR = MC. At that quantity, profit is equal to total revenue (80 x $40) minus total cost (80 x $34) = $480]
Sahara, a popular YouTuber, now works from home. Before the pandemic she was a local high school teacher who made $68,500 per year and rented out her garage to a local artist for $1,000 a month. Her video on making DIY hand sanitizer went viral, and she now has a lucrative contract that pays her $7,800 per month in advertising fees. Sahara can no longer teach and is now using her garage as her warehouse. In addition to the monthly income she collects from advertisers on her YouTube channel, she was also able to sell $42,000 in hand sanitizer. Her total expenses were $57,000 for supplies. Calculate Sahara's yearly accounting profit.
~$78,600 [Accounting profit is calculated by adding up her revenue and subtracting explicit costs she incurred] *[((7800*12) + 42000) - 57000 =78600]
In this particular market, there has been a short-run decrease in demand. As a result, a number of firms have left the market, which causes supply to fall and prices to rise once again to long-run market equilibrium. Drag the labels into place in the figure for an individual firm that is returning to equilibrium price after a short-run fall in demand.
area above ATC slope ~profitable operation P1 = C1 ~long-run price P2 ~short-run price q2 ~short-run quantity q1 ~long-run quantity area under MR2 ~unprofitable operation [A return to equilibrium includes a return to the MR = MC]
Match each concept to a corresponding example.
cost of fuel to run a factory workspace heating system during the winter ~explicit cost total revenue minus fixed and variable costs associated with plant operations ~accounting profit total revenue minus all costs, including opportunity costs ~economic profit lost income due to investing in machinery retooling rather than materials to produce more units ~implicit cost [A company needs to show a positive accounting profit to stay in operation. For economic profit, it is sufficient to stay at zero]
Drag the labels into place in the figure for a market leaving, and then returning to, equilibrium as firms exit after a decrease in demand.
dark red slope ~final short-run supply light red slope ~original short-run supply horizontal line (P1) ~long-run supply light blue slope ~original short-run demand dark blue slope ~final short-run demand *[The final equilibrium price is the same as the original price]
Consider the following information for a fictional firm. Changes in profit comes from selling one more unit (and receiving MR) minus the cost of producing this additional unit (MC). Fill in the blanks to complete the sentence about production. Quantity produced (units) 3,000, 5,000, 7,000 Change in profit (dollars) $3, $0, -$1 The firm should produce - units, because that is the quantity of production where -, which maximizes -.
~5,000 ~marginal revenue = marginal cost ~profit *[Below 5,000 units, change in profit is positive, so the firm can make more money by selling more units. Above 5,000 units, change in profit is negative, so the firm is losing money on each unit past the 5,000-unit mark]
Assume all firms represented in the graph have the same cost functions and that they begin at a long-run equilibrium. Now suppose that a large number of new consumers enter the market. Which of the following would be the correct order of steps to represent this change in the market and that would result in long-run equilibrium?
~A to B to C [The number of new consumers increases the demand, which increases the market price to P2. Firms are earning a profit, which causes new firms to enter. New firms drive the market price down to P1 and the long-run output increases]
Select the segment that functions as the individual firm's short-run supply curve.
~MC top slope [The firm will produce as long as price is greater than or equal to minimum AVC. This makes the upward-sloping segment of MC starting at minimum AVC and going upward function as the firm's short-run supply curve] ~MC middle slope [The firm will produce as long as price is greater than or equal to minimum AVC. This makes the upward-sloping segment of MC starting at minimum AVC and going upward function as the firm's short-run supply curve]
An ice-cream street vendor operates out of a small truck. He considers replacing the truck with a larger one but decides not to. Apply the appropriate label to each cost.
increased profits that would have been made possible by a larger truck ~opportunity cost [Profits not realized because of the decision not to purchase the bigger truck are an opportunity cost] cost of buying ice cream from wholesaler each week ~variable cost [Since the total cost from ice cream rises as more units are sold, it is a variable cost] annual fee for operating permit ~fixed cost [Since the fee doesn't vary with the number of ice cream cones sold, it is a fixed cost] purchase cost of current truck (paid off last year) ~sunk cost [The truck expense is in the past and should not be a factor in ongoing business decisions]
The following graphs represent a given market and a firm within the market. Suppose there is a decrease in the market demand. With a beginning point of a long run equilibrium, select three points, two in Figure (a) and one in Figure (b), that represent a market in the middle of adjusting to a decrease in market demand in the short run.
left graph ~dotted line @ C2 & q2 [This is the firm's average cost per item at the lowered production quantity Q2] ~solid line & dotted line @ P2 & q2 [The price has dropped to P2, and the individual firm has responded by reducing its output to Q2] right graph ~dotted line @ P2 & Q2 [The shift in the demand curve has dropped the equilibrium price from P1 to P2 and the quantity supplied from Q1 to Q2]
Identify the characteristics of markets with perfect competition.
perfect competition ~There is a large number of firms [Perfectly competitive markets have hundreds to thousands of firms] ~Firms have no price control [Firms and consumers are price takers, always charging or paying market equilibrium prices] ~Firms produce very similar products [Standardized or homogenous goods are produced under perfect competition] ~Firms are very small relative to the market [Perfectly competitive firms produce less than 1% of the total market output] not perfect competition ~Firms have significant price control [This is a property of pure monopoly and some oligopolies] ~There are significant barriers to entry and exit to the market [Perfect competition has no significant barriers to entry or exit] ~Firms produce differentiated products [This is a property of monopolistic competition and some oligopolies] *[Market structures have many descriptive attributes, and it is all of these that distinguish markets from each other]
A firm regulates its production so that marginal cost (MC) matches marginal revenue (MR). Drag each descriptive phrase into the appropriate region of the figure.
top area ~profitable [Revenue covers both fixed and variable costs] middle area ~losing money but should continue operating [Revenue covers the variable cost associated with continued production and some of the fixed cost. Losses are minimized by continuing to operate] bottom area ~should shut down production [Revenue cannot cover the variable cost associated with continued production. Losses will be reduced by shutting down]
Place in order the events that take place in the long run, in a perfectly competitive market, when quantity supplied is greater than quantity demanded.
~market surplus causes a drop in price ~lowered price means negative economic profits ~negative profits are a signal to some firms to exit the market ~as some firms exit, quantity supplied drops ~equilibrium is reached, where quantity supplied equals quantity demanded *[A similar chain of events takes place when quantity supplied is less than quantity demanded. The profitability of firms is a signal for firms to enter or leave the market]
Fill in the blanks to complete the passage about short-run operating loss. In the short run, a profit-maximizing firm should operate even when it is losing money, so long as the market - is above -. In this situation, continued operation enables a firm to cover all of its - and some of its - with any remaining revenue.
~price ~average variable cost ~variable cost ~fixed cost *[If the company can cover some of its fixed cost, it will do better by producing than by shutting down in the short run. This is because the firm must still pay all of its fixed costs in the short run]
Which information would be enough to determine a firm's profit, given that Q = 10,000 units?
~price, total cost [Price × Q equals total revenue, and profit = total revenue - total cost. Keep in mind, (price - average total cost) × Q is also profit, because ATC = TC ÷ Q, so TC = ATC × Q]
Which descriptions apply to the long-run equilibrium in a perfectly competitive market?
Applies to Market Equilibrium ~Economic profit is zero ~No "exit" or "enter" signals are being sent ~Firms outside the market have no incentive to enter ~Firms in the market have no incentive to exit Does Not Apply to Market Equilibrium ~Firms will raise their prices to increase profits [In competitive markets, firms are price takers and do not choose the selling price] ~Accounting profit is zero [Accounting profit must be positive. It does not factor in certain costs, such as opportunity costs] *[In equilibrium, being in the market and being out of it are equally attractive, as reflected by economic profit being zero. Accounting profit must be positive]
Identify the characteristics that describe a competitive market or a "price taker" firm within the market.
Describes a Price Taker ~The firms can enter and/or exit the market at will [Competitive markets are considered to have free exit or entry] ~There are many similar firms in the market [The number of firms in the market means each one has little to no impact on the market price] Does Not Describe a Price Taker ~The firm will attempt to run competitors out of business to increase profits [Competitive markets have free exit and entry, so if one firm leaves, another may soon replace it. Also, given the number of firms selling a similar product, this strategy is likely to fail] ~The firm sells at lower prices to increase sales [If a firm can lower its price to increase sales, then it is not a price taker, and this is not a competitive market. In a competitive market, competition among firms will drive down the price to the point where firms are not earning profits. At this point, firms cannot lower prices further, or they will lose money] ~There is only one main competitor in the market [With only one firm, the firm can set the price and is therefore not a "price taker."] *[Firms in a competitive market will accept the market price as being out of their control (price takers), and because there are so many other firms selling the same product or service, they likely pay little attention to how competitors operate and focus only on themselves]
The following options describe costs incurred by owners of a given business. Identify which would be considered a sunk cost for a firm that is considering exiting a market.
Sunk Cost ~a new large billboard sign displaying "Shantel's Shoes" for Shantel's Shoe Shop [Unless Shantel knows someone else with the same name who sells shoes and likes her sign, Shantel is unlikely to sell her sign to another firm] ~four wedding cakes for Carlos's Cakes Shop [Cakes are the final good and can be sold, but the costs or ingredients (like sugar, flour, and eggs) in the cake cannot be resold] ~the cost of taking two online photography classes by Philipe of Philipe's Photography Shop [Once Philipe takes the online classes, what he paid is not a recoverable cost] Not a Sunk Cost ~the cost of two riding lawn mowers for Luke's Lawn Care [Lawn mowers are equipment that can be sold, so at least some of the cost can be recovered] ~fireworks for Frida's Fireworks Displays [Sunk costs are unrecoverable—if you cannot recover costs in a business, they should not be part of the decision to stay or exit a market]
Which statements are true in the long run for a company operating with negative economic profit and positive accounting profit?
True Statement(s) ~The firm will most likely exit the market [Negative economic profit indicates better opportunities elsewhere, outside the market] ~Operation is sustainable but not advisable [With negative economic profit, the rational thing for the firm to do is exit the market] Not a True Statement ~Operation is not sustainable [With positive account profit, the firm could continue to operate] ~The firm will most likely stay in the market [Negative economic profit is a signal to exit]
Which of the following conditions are true when a firm is maximizing its profits?
True When a Firm Is Maximizing Profits ~Revenue gained from the next unit sold equals the cost of producing it [This condition is often stated as marginal revenue (MR) = marginal cost (MC)] ~Selling additional units will reduce profits [Beyond the optimal point, marginal costs exceed marginal revenue, and profits will decrease as each unit costs more than the revenue earned from selling it] Not True When a Firm Is Maximizing Profits ~Total revenue is maximized [Total revenue is maximized only when marginal revenue is equal to zero, which is typically at a high level of production. Producing so many units also increases total costs. This can decrease profits or potentially create a loss] ~Total number of units sold is maximized [A firm maximizing its profits does not necessarily mean it is producing the most units it possibly can. At a certain point of production, no more profitable opportunities exist, and continued production will result in losses] ~Revenue gained from the next unit sold equals zero [To sell a unit is to receive money in exchange, so revenue will not equal zero] *[Firms maximize their profits by selling units until marginal revenue equals marginal cost, and no more]
Place the following U.S. markets in order from least competitive to most competitive.
~Middletown Regional Electric company, the only provider of electricity to the region [Electricity is usually provided by a single provider, making the electricity market a monopoly so that one firm does not compete with itself. The fixed startup costs are high, including the cost of the distribution network] ~Coca-Cola Company, one of two main firms in the beverage market [The cola market is dominated by Coca-Cola and PepsiCo. The fixed startup costs in this market are less than in the electricity market, but they are not negligible. Two firms is not "many," and some consumers do not consider Coke and Pepsi to be perfect substitutes, but they still compete in the cola market] ~Tony's Tomatoes, a tomato seller at a farmer's market with many other tomato sellers [There are many direct farmer sellers at a farmers' market, most of whom sell similar products. The fixed cost of starting up a produce stand is relatively small, making entry close to "free," and this increases the number of options for consumers to choose from]
Imagine a perfectly competitive market where all the firms have the cost structure shown below. Where will the long-run equilibrium market price settle?
~P2 [Firms choose an output where MR = MC, so P2 × Q = TR and ATC × Q = TC. There is no economic profit at P2. The long-run price occurs where there is no incentive for firms to enter or leave the market]
Select the quantity on the graph that will maximize the profits for the perfectly competitive producing firm.
~Q3 [Choosing output based on MR being equal to MC will lead to the maximum possible economic profits]
Of the four quantities shown, assuming the market price remains the same, select the output that leads to a normal profit or break-even point. (Keep in mind that this concept is different from the profit-maximizing output.)
~Q4 [When P* = ATC, TR = TC, which leads to a $0, or normal, profit]
The cost and revenue information for a firm is shown in the figure below. Select the regions whose combined area represents the firm's profit when MR = MC.
~area on point on dotted & solid line @ P & Q [This is part of the short-run profit-maximizing profit for this firm] ~area between P & ATC [This is part of the short-run profit-maximizing profit for this firm]
Consider a profit-maximizing firm in the short run which chooses to remain open while it is losing money. Place the following values in order from lowest to highest to represent a firm in this situation.
~average variable cost ~price ~average total cost *[In the short run, managers can control only variable costs, such as how many employees to hire or how much inventory to have on hand. In the long run, managers can vary all their costs and can expand or decrease the size of their operation to best suit their production goals. A firm will operate at a loss when price is below ATC but above AVC]
Fill in the blanks to complete the passage about profits and losses in a perfectly competitive retail market in the long run. When - firms are making a profit, this is a signal to other firms to enter the market. The result is increased -, which leads to a reduction in price and therefore a reduction in profit. In long-run equilibrium, - profit is zero; there is no signal to enter and no signal to -.
~existing ~supply ~economic ~leave *[Profit and loss signals are a kind of feedback mechanism that maintains market equilibrium]
Consider a fish vendor selling salmon in a competitive market. A single fish vendor will be able to sell his salmon at a higher price than his competitors and affect the market price of fish.
~false [In a competitive market, price is determined by the supply and demand conditions in the marketplace, not by an individual seller]
At a market price of $10, the profit-maximizing output for Mr. Plow is 9 driveways. Quantity (Q = driveways cleared) 0, 1, 2, 3, 4, 5, 6, 7, 8, 9, 10 Total revenue (TR) 0, 10, 20, 30, 40, 50, 60, 70, 80, 90, 100 Total cost (TC) 20, 29, 36, 41, 44, 46, 49, 57, 67, 90, 140
~false [Increasing from 8 driveways to 9, the MR = 10 but the MC = 23. At 8 driveways, the MR = 10 and the MC = 10, so Mr. Plow would stop clearing at 8 driveways with a profit of $13]
The profit-maximizing rule leaves room for cases where it is both possible and reasonable for a firm to operate at a loss over the long run.
~false [Since all costs are variable in the long run, a firm can always set its profit to zero by ceasing operation (exit)]
The short-run supply curve for a firm in a competitive market (as shown in the graph) will start at a market price of $4.
~false [The short-run supply curve will start at $2. Any time the market price is below minimum ATC but above minimum AVC, the firm will continue to operate, though at a loss, because the firm can still cover all variable costs and some fixed costs. The firm will shut down when the market price falls below the AVC]
The following graphs model adding individual firms' supply curves to obtain a market supply curve. Which of the following explains why the graph on the left is correct and the graph on the right is incorrect?
~firms sell at the same price, and total supply is the sum of individual quantities supplied [The market price is the same for everyone, and it equals each firm's marginal cost]
As the graph below illustrates, the long-run supply curve for a single firm, SLR, is vertical below the dashed line and coincides with the MC curve above the dashed line. What does this mean?
~firms will produce when the price is above minimum average total cost; a firm will exit the market when price is below average total cost [Realistically, no firm will continue to supply goods in a market where doing so generates a long run loss. In the long run, firms will exit the market when the price falls below the minimum ATC]
Fill in the blanks to complete the statement about positively sloped long-run market supply curves. In the simplest kind of case, the long-run market supply curve is perfectly -. However, more realistically it may slope -, if increasing the - leads to increased production costs, due to shortages in either material or -.
~horizontal ~upward ~quantity supplied ~labor *[A perfectly horizontal supply curve is a simplifying idealization]
In a perfectly competitive market, the long-run market supply curve tends to be horizontal or nearly so (very price sensitive). What is another way to state this fact?
~in the long run, the market will supply any amount of the good at the price where P = min. ATC [Both supply and demand are more elastic in the long run than the short run, which corresponds to a leveling out of the supply and demand curves]
Reece prepaid for a trip over spring break in 2020, right before major cities started to issue lockdown mandates due to rapid spread of the coronavirus. Given all the uncertainty around travel and disease spread, she tried to get a refund, but was told it was too late. She felt very uncomfortable going and knew she would not enjoy her trip at all. Therefore, she made new plans to spend spring break on campus binge-watching her favorite TV shows. An economist would explain Reece's decision to be - because she - the prepaid cost, and made her decision based on the marginal benefit and cost of going. In economics these prepaid costs would be referred to as - costs, which are unrecoverable.
~rational ~ignored ~sunk *[Try to think of times where someone has based a decision off previous costs that have been incurred. For example, suppose a friend comes to you about a class he or she is failing; you both look at the grades and determine there is no way to pass the course at this point. However, your friend insists on not dropping because of all the work already put into this course. A good economist would remind your friend that just because time has been spent on a class he or she cannot pass, it is not rational to continue]
Fill in the blanks to complete the statement about competitive markets. There are many - in a competitive market. Firms in this market sell very - products, and each firm also has - to the market. Each firm is also considered a price -.
~sellers ~similar ~easy entry and exit ~taker *[The four characteristics of competitive markets provide a checklist for determining why certain markets are not competitive]
To maintain the goal of maximizing profits, as conditions and new information change, firms typically adjust production decisions based on marginal revenue and cost, rather than total revenue and cost.
~true [Firms use marginal analysis (comparing marginal revenue with marginal cost) when making day-to-day decisions]
During a short-run period where market supply is adjusting to decreased market demand, individual firms that choose to remain in the market will operate at a loss because price, and therefore marginal revenue, is less than average total cost.
~true [In perfectly competitive markets, firms are price takers, and thus are bound to the price as dictated by market demand. When demand falls, firms will operate at a loss until enough firms leave the market causing supply to fall and price to return to equilibrium]
Fill in the blanks to complete the passage about the figure. In the short run, some costs are fixed and the rest are variable. A firm will continue production only so long as it can cover at least its - costs. Therefore, production will only occur when price, and therefore marginal revenue, - average variable cost. Where that condition is met, the marginal cost curve - the short-run supply curve, because it is only along this line that marginal cost equals marginal revenue.
~variable ~equals or exceeds ~becomes *[This concept also applies in the long run—the difference being there are no fixed costs in the long run. All costs are variable, and so a firm remains in business only if marginal cost exceeds average total cost]
Fill in the blanks to complete the passage regarding sunk costs for a manufacturer of ethanol. Ethanol, a biofuel derived from corn, is used in the production of both gasoline and pharmaceutical-grade hand sanitizer. During the pandemic, as the demand for gasoline plummeted, several producers of ethanol retrofitted their plants by purchasing new capital in order to produce a higher-quality ethanol, which could be used to make a medical-grade hand sanitizer. Future decisions about whether to produce ethanol for gasoline or for hand sanitizer - be informed by the - costs they incurred to retrofit their plant.
~would not ~sunk *[Good economists learn to ignore sunk costs and focus on marginal value. They compare marginal benefits and marginal costs]
