EC215 Exam 2 Study Guide: Chapter 12
If P = ATC, is the firm making a profit, breaking even, or making a loss?
Breaking Even
Identify the number of firms, type of product, ease of entry, and examples of industries for Perfect Competition
Many Identical High Growing wheat, poultry farming
What is the difference between Allocative Efficiency and Productive Efficiency?
Productive efficiency pertains to production within an industry while allocative efficiency pertains to production across all industries
Define Profit
Total Revenue - Total Cost Maximized when MR = MC
Define Average Revenue
Total Revenue / Quantity of Product Sold
To maximize profit, what quantity of wheat should a farmer produce?
Where the difference between the total revenue he receives and his total cost are as large as possible
What are the two options a firm has if they're making a loss?
1. Continue to produce 2. Stop production by shutting down temporarily. But, if they shut down temporarily, they must still pay their fixed costs. The firm will completely shut down if producing would cause it to lose an amount greater than its fixed cost
Define Price Taker
A buyer or seller that is unable to affect the market price. This is because they are tiny relative to the market and sell the same product as everyone else. Perfectly competitive markets are price takers. Their sales drop to zero if they attempt to charge more than the market price.
Define Sunk Costs
A cost that has already been paid and can't be recovered
Define Economic Profit
A firm's revenue minus all its costs, implicit and explicit
Define Industry
All the firms selling a particular good or services. Ex: Eggs, automobiles, life insurance
Identify the number of firms, type of product, ease of entry, and examples of industries for Oligopoly
Few Identical or differentiated Low Manufacturing computers, manufacturing automobiles
Draw a graph showing a firm that is making a profit in a perfectly competitive market. Be sure your graph includes the firm's demand curve, marginal revenue curve, marginal cost curve, average total cost curve, and average variable cost curve and make sure to indicate the area representing the firm's profit
Figure 12.4 on page 415
What does the demand curve look like for a perfectly competitive firm?
Horizontal
Fill in the missing values on the following table
Page 437 problem 4.5
Define Productive Efficiency
Results from perfect competition. Goods and services are produced at the lowest possible cost
Define Allocative Efficiency
Results from perfect competition. Goods and services are produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it
How do you figure out the area of maximum profit on a graph?
The area of the rectangle where the height is P-ATC (the top of the rectangle is the horizontal demand curve) and the width is Q (which is where MC intersects the demand curve)
If a firm's price never exceeds the average cost, what do we do?
The best this firm can do is break even, so use the profit-maximizing level of output at the point where MC = MR (where the MC touches the demand curve)
Would a firm earning zero economic profit continue to produce, even in the long run?
The firm will continue to produce because such profit is as high as return as could be earned elsewhere
What determines the equilibrium price of a product like wheat?
The interaction of market supply and market demand determines the equilibrium price which all sellers must accept
Discuss the shape of the long-run supply curve in a perfectly competitive market.
The long-run supply curve is a horizontal line equal to the minimum point on the typical firm's average total cost curve
If the firm is making a loss, what do we do to figure out the loss?
The loss is a rectangle where the width is Q (where MC intersects with the horizontal demand curve) and the height is the difference between the ATC and horizontal demand curve
What are the three conditions of a perfectly competitive market?
1. There are many buyers and sellers 2. All firms sell identical products 3. There are no barriers to new firms entering the market
Identify the following for Apple Growing: 1. Perfectly Competitive? 2. Number of firms 3. Type of Product 4. Ease of entry
1. Yes 2. Many 3. Identical 4. High
Define Long-Run Supply Curve
A curve that shows the relationship in the long run between market price and the quantity supplied
What is the relationship between a perfectly competitive firm's marginal cost curve and its supply curve?
A firm's marginal cost curve is equal to its supply curve for prices above average variable cost
If marginal revenue exceeds marginal cost, a perfectly competitive firm should: A. expand output. B. reduce output. C. lower its price. D. do both a and c.
A. expand output.
Marginal revenue is: A. the change in total revenue from producing one additional unit of output. B. the economic profit from producing an additional unit of output. C. the change in total cost from producing an additional unit of output. D. another name for total revenue.
A. the change in total revenue from producing one additional unit of output.
In the long run, a perfectly competitive firm (price taker) earns: A. zero economic profit. B. a positive economic profit. C. zero accounting profit. D. an economic loss.
A. zero economic profit.
Draw a graph showing a firm that is operating at a loss in a perfectly competitive market. Be sure your graph includes the firm's demand curve, marginal revenue curve, marginal cost curve, average total cost curve, and average variable cost curve and make sure to indicate the area representing the firm's profit
Figure 12.5b on page 418
What is the difference between a firm's shutdown point in the short run and in the long run? Why are firms willing to accept losses in the short run but not in the long run?
In the short run, a firm's shutdown point is the minimum point on the average variable cost curve, while in the long run, a firm's exit point is the minimum point on the average total cost curve. Firms are willing to accept losses in the short run because there are sunk costs in the short run but not in the long run
The graph represents the situation of a perfectly competitive firm. Determine the areas on the graph that represent the following:
Online practice problem for 12.4
Which demand curve in the graph is associated with the shutdown point for this perfectly competitive firm?
Online practice problem for 12.4
What is the relationship between Price, Average Revenue, and Marginal Revenue in a perfectly competitive market? Explain.
Price = Average Revenue = Marginal Revenue This is because firms can sell as much output as they want at the market price
Define Economic Loss
The situation in which a firm's total revenue is less than its total cost, including all implicit costs.
Define Long-Run Competitive Equilibrium
The situation in which the entry and exit of firms has resulted in the typical firm breaking even
Why are perfectly competitive industries unable to earn an economic profit in the long run?
1. Firms in these industries sell identical products 2. It is easy for new firms to enter these industries
Identify the following for Constructing New Homes: 1. Perfectly Competitive? 2. Number of firms 3. Type of Product 4. Ease of entry
1. No 2. Few 3. Differentiated 4. Low
Identify the following for Manufacturing Cell Phones: 1. Perfectly Competitive? 2. Number of firms 3. Type of Product 4. Ease of entry
1. No 2. Few 3. Differentiated 4. Low
Identify the following for Sub Sandwich Shops: 1. Perfectly Competitive? 2. Number of firms 3. Type of Product 4. Ease of entry
1. No 2. Many 3. Differentiated 4. High
What are the three key characteristics of an industry?
1. The number of firms in the industry 2. The similarity of the good or service produced by the firms in the industry 3. The ease with which new firms can enter the industry
What are the rules for profit maximization?
1. The profit-maximizing level of output is where the difference between total revenue and total cost is the greatest 2. The profit-maximizing level of output is also where MR = MC 3. (For perfectly competitive firms only) The profit-maximizing level of output is also where P = MC
When firms in a perfectly competitive market are able to earn economic profits: A. the firms will earn long-run economic profit. B. additional firms will be attracted into the market until price falls to the level of average total cost. C. the firms will earn short-run economic profits that will be offset by long-run economic losses. D. the existing firms must be colluding or rigging the market, otherwise, they
B. additional firms will be attracted into the market until price falls to the level of average total cost.
Suppose a restaurant that is highly profitable during the summer months is unable to cover its total cost during the winter months. If it wants to maximize profits, the restaurant should: A. shut down during the winter, even if it is able to cover its variable costs during that period. B. continue operating during the winter months if it is able to cover its variable costs. C. go a out of business immediately; losses should never be tolerated. D. lower its prices during the summer months
B. continue operating during the winter months if it is able to cover its variable costs.
When we say that a firm is a price taker, we are indicating that the: A. firm takes the price established in the market then tries to increase that price through advertising. B. firm can change output levels without having any significant effect on price. C. demand curve faced by the firm is perfectly inelastic. D. firm will have to take a lower price if it wants to increase the number of units that it sells.
B. firm can change output levels without having any significant effect on price.
Why are consumers so powerful in a market system?
Because it is consumers' demand that influences the market price and dictates what producers will supply in the market
How is the market supply curve derived from the supply curve of individual firms?
By horizontally adding the individual firms' supply curves
In a perfectly competitive market, individual firms have no control over price. Therefore, the firm's marginal revenue curve is: A. a downward-sloping curve. B. indeterminate. C. constant at the market price of the product. D. precisely the same as the firm's total revenue curve.
C. constant at the market price of the product.
Define Marginal Revenue
Change in Total Revenue / Change in Quantity The change in total revenue from selling one more unit of a product
The demand curve for a competitive market is _________ while the demand curve for a price taker (a perfectly competitive firm) is _________: A. horizontal; downward sloping B. downward sloping; downward sloping C. horizontal; horizontal D. downward sloping; horizontal
D. downward sloping; horizontal
The characteristics that describe a perfectly competitive market include: Select one: A. one seller selling to many buyers. B. a few firms selling to many buyers. C. many firms selling a slightly differentiated product. D. many firms selling an identical product.
D. many firms selling an identical product.
A firm maximizes its profit by producing the amount of output such that marginal: A. revenue is maximized. B. revenue exceeds marginal cost. C. cost is minimized. D. revenue equals marginal cost.
D. revenue equals marginal cost.
When are firms likely to enter an industry? When are they likely to exit an industry?
Economic profits attract firms to enter an industry, and economic losses cause firms to exit an industry
The firm's shut down decision is based off what?
Its variable costs. If P < AVC, the firm should produce 0 units of output.
If P < ATC, is the firm making a profit, breaking even, or making a loss?
Making a Loss
Identify the number of firms, type of product, ease of entry, and examples of industries for Monopolistic Competition
Many Differentiated High Clothing stores, restaurants
Identify the number of firms, type of product, ease of entry, and examples of industries for Monopoly
One Unique Entry blocked First-class mail delivery, providing tap water
If P > ATC, is the firm making a profit, breaking even, or making a loss?
Profit
What is the equation to figure out a firm's total profit?
Profit = (P-ATC) x Q
When maximizing profits, why is MR = MC?
The marginal revenue curve for a perfectly competitive firm is the same as its demand curve
Define Shutdown Point
The minimum point on a firm's average variable cost curve; if the price falls below this point, the firm shuts down production in the short run
How do you figure out the profit/loss of a firm if you're using a graph?
The vertical difference between the two curves (total revenue and total cost). If costs are lower than revenues, there's a profit. If costs are greater than revenues, there's a loss.