econ ch 12

3)In perfect competition, an individual firm A)has perfectly elastic supply. B)faces unitary elasticity of demand. C)has a price elasticity of supply equal to one. D)faces a perfectly elastic demand.

3) Answer: D. Because all firms are assumed to produce identical products, the output of any particular firm is a perfect substitute in consumption for the output of any other firm. As a result, the price elasticity of demand for any particular firm's output is very high - we are assuming the demand facing any one firm is perfectly elastic.

29) In the short run, a decrease in demand for a product that is sold in a perfectly competitive market will necessarily A) have no effect on the price. B) decrease the outputs and profits of existing firms in the market. C) cause all of the firms to shut down. D) cause firms to exit the industry and/or decrease their plant size.

29) Answer: B. The decrease in the price will cause profitability to decline. Some firms might want to exit the industry, but, by definition, this cannot happen in the short run - the number of firms will remain the same until the long run comes around. The existing firms will experience a lower price and hence marginal revenue and will respond by moving south west along their marginal cost curves to try maintain the MR = MC profit maximization condition. If the price falls enough (below min AVC), the firms will all shut down and produce zero output (an extreme case of decreasing output), but this is not something that will necessarily happen.

5)In perfect competition, A)there are few buyers. B)all firms in the market sell their product at the same price. C)there are significant restrictions on entry. D)each firm can influence the price of the good.

5) Answer: B. In perfect competition, there are many buyers and many sellers. This ensures that no buyer or seller has market power, the ability to influence the price of the good. Further, because all firms are assumed to produce identical products, the output of any particular firm is a perfect substitute in consumption for the output of any other firm and, because of this, the demand facing any one firm is perfectly elastic. As a result, each firm is a price taker (it takes the market price as given and beyond its control) and all firms sell at the same price.

6)As perfectly competitive firms leave an industry because they are incurring an economic loss, the price of the good ________ and the economic loss of each remaining firm ________. A)rises; increases B) falls; increases C)falls; decreases D) rises; decreases

6) Answer: D. The assumption that there are no restrictions on entry or exit in the long run in perfect competition ensures that firms that earn economic losses in the short run will exit in the long run. As firms exit in the long run, the market supply decreases (shifts left) and the equilibrium price rises. As the price rises, the profits of the remaining firms increase (here, the profits are negative initially, so the economic losses decrease).

1)Perfect competition achieves efficiency if ________. A)producer surplus equals zero B)consumer surplus is greater than producer surplus C)marginal benefit is greater than marginal cost D)there are no external benefits and no external costs and the good is not a public good

1) Answer: D. In Ch 5 we learned that, as long as we rule out price ceilings/price floors, taxes, subsidies, quotas, monopoly (and monopsony), public goods, external costs and external benefits, high transactions costs and/or incomplete or asymmetric information, markets yield allocatively efficient outcomes. The assumptions of the model of perfect competition explicitly rule out all of these except for public goods and external costs and benefits.

10)Because of a decrease in the wage rate it must pay, a perfectly competitive firm's marginal costs decrease but its demand curve stays the same. As a result, the firm A)decreases the amount of output it produces and lowers its price. B)decreases the amount of output it produces and raises its price. C)increases the amount of output it produces and lowers it price. D)increases the amount of output it produces and does not change its price.

10) Answer: D. We learned in chapter 11 that a decrease in the cost of a variable input reduces a firm's marginal cost (MC) and average variable cost (AVC) but leaves its average fixed cost (AFC) unchanged. Because average total cost (ATC) is the sum of AVC and AFC, it, too decreases. The demand curve facing an individual competitive firm is perfectly elastic at the market price and this dollar amount also equals its marginal revenue. The firm maximizes its profit by producing a quantity of output such that marginal revenue equals marginal cost. If marginal cost decreases, marginal revenue will be equal to marginal cost at a greater level of output. In the image below, marginal cost decreases from MC1 to MC2 and the profit maximizing output increases from Q1* to Q2*:

15)A firm will expand the amount of output it produces as long as its A)marginal revenue exceeds its marginal cost. B)marginal cost exceeds its marginal revenue. C)average total revenue exceeds its average total cost. D)average total revenue exceeds its average variable cost.

15) Answer: A. If MR > MC, the firm adds more to its total revenue than it adds to its total cost when it produces one more unit of output, and economic profit increases. [If MR < MC, the firm adds more to its total cost than it adds to its total revenue when it produces one more unit of output, and economic profit decreases.] Please see slide #19 (the slide with the total revenue bucket and the total cost bucket) in my Powerpoint notes.

16)A perfectly competitive firm shuts down in the short run if the price of its product is A)less than its minimum average variable cost. B)less than its minimum total cost. C)greater than its maximum variable cost. D)greater than its minimum average variable cost.

16) Answer: A. The shutdown point is the point at which average variable cost (AVC) is at its minimum. This point is also identified as the point where marginal cost (MC) equals average variable cost (AVC). A firm will shut down in the short run if its total revenue cannot cover its total variable cost, in other words, if total revenue < total variable cost. This condition is TR < TVC P∙Q < AVC∙Q P < AVC.

17)At a firm's break-even point, definitely its A)marginal revenue equals its average fixed cost. B)total revenue equals its total opportunity cost. C)marginal revenue equals its average variable cost. D)marginal revenue exceeds its marginal cost.

17) Answer: B. At the break-even point, total revenue equals total opportunity cost and economic profit is zero (the firm is earning enough revenue to earn exactly a normal profit). Total opportunity cost includes explicit and implicit costs; we know from chapter 10 that normal profit is among the latter.

18)If perfectly competitive firms exit an industry, the A)industry supply curve shifts leftward. B)profits of the remaining firms decrease. C)output of the industry increases. D)price of the good or service falls.

18) Answer: A. If perfectly competitive firms exit an industry, the industry supply curve shifts leftward. This causes the equilibrium price to rise and the profits of the remaining firms to increase.

19)In perfect competition, the marginal revenue of an individual firm A)is zero. B)exceeds the price of the product. C)equals the price of the product. D)is positive but less than the price of the product.

19) Answer: C. In perfect competition, there are many buyers and many sellers. This ensures that no buyer or seller has market power, the ability to influence the price of the good by altering its output. Each firm is a price taker (it takes the market price as given and beyond its control) and all firms sell at the same price. The firm can sell as many or as few units as it wants at the market price without being able to affect that price. Its marginal revenue is the market price and the demand curve that the typical firm faces is perfectly elastic at that price: D = MR = P.

2)In perfect competition, the product of a single firm A)has many perfect complements in consumption produced by other firms. B)is sold to different customers at different prices. C)is sold under many differing brand names. D)has many perfect substitutes in consumption produced by other firms.

2) Answer: D. Because all firms are assumed to produce identical products, the output of any particular firm is a perfect substitute in consumption for the output of any other firm.

21)Perfect competition arises if the ________ efficient scale of a single producer is ________ relative to the demand for the good or service. A)maximum; large B) minimum; large C)minimum; small D) maximum; small

21) Answer: C. The minimum efficient scale is the smallest level of output at which the average total cost of the typical firm is at its minimum. If the minimum efficient scale is small relative to the quantity demanded at the price corresponding to the minimum efficient scale, many firms can coexist in the market. By contrast, if the minimum efficient scale is large and, for example, half of the quantity demanded, only two firms would be able to coexist. And if the minimum efficient scale is greater than the quantity demanded at that price, the result will be a single firm - a natural monopoly (we will study this in the next chapter.)

22)By producing less, a firm can reduce A)its fixed costs but not its variable costs. B)its variable costs but not its fixed costs. C)its fixed costs and its variable costs. D)neither its variable costs nor its fixed costs.

22) Answer: B. By definition, a firm's fixed cost does not vary as the level of output changes. Even if the firm produced a quantity of zero, it would still have to pay its fixed cost. In contrast, a firm's variable cost does vary as the level of output changes. If the firm produces more, it must hire more of the variable input(s) and its total variable cost will be greater. If the firm produces less, it must hire less of the variable input(s) and its total variable cost will be smaller.

23)The market for lawn services is perfectly competitive. Larry's Lawn Service cannot increase its total revenue by raising its price because ________. A)Larry's supply of lawn services is inelastic B)the demand for Larry's services is perfectly inelastic C)Larry's supply of lawn services is perfectly inelastic D)the demand for Larry's services is perfectly elastic

23) Answer: D. Larry's Lawn Service is a price taker and the demand facing this particular individual firm is perfectly elastic. If Larry raises his price, he will lose all of his customers because there are many other identical firms offering products identical to his.

26) Suppose firms in a perfectly competitive industry are enjoying economic profits in the short run. Over time, A) some firms leave the industry, so the price falls and the economic profits decrease. B) other firms enter the industry, so the price falls and the economic profits decrease. C) other firms enter the industry, so the price rises and the economic profits decrease. D) some firms leave the industry, so the price rises and the economic profits decrease.

26) Answer: B. The assumption that there are no restrictions on entry or exit in the long run in perfect competition ensures that, when the firms in an industry earn economic profits in the short, other firms will enter the industry in the long run. As firms enter in the long run, the market supply increases (shifts right) and the equilibrium price falls. As the price falls, the profits of the firms decrease.

27) In the short run, a firm will shut down if its total revenue cannot cover its A) total cost. B) total fixed cost. C) total variable cost. D) marginal cost.

27) Answer: C. The shutdown point is the point at which average variable cost (AVC) is at its minimum. This point is also identified as the point where marginal cost (MC) equals average variable cost (AVC). A firm will shut down in the short run if its total revenue cannot cover its total variable cost, in other words, if total revenue < total variable cost. This condition is TR < TVC P∙Q < AVC∙Q P < AVC.

28) A competitive firm is producing the level of output that maximizes its profits. Subsequently, its variable costs decrease. To maximize profits, the firm should A) decrease its output. B) shut down. C) not change its output. D) increase its output.

28) Answer: D. We learned in chapter 11 that a decrease in the cost of a variable input reduces a firm's marginal cost (MC) and average variable cost (AVC) but leaves its average fixed cost (AFC) unchanged. Because average total cost (ATC) is the sum of AVC and AFC, it, too decreases. The demand curve facing an individual competitive firm is perfectly elastic at the market price and this dollar amount also equals its marginal revenue. The firm maximizes its profit by producing a quantity of output such that marginal revenue equals marginal cost. If marginal cost decreases, marginal revenue will be equal to marginal cost at a greater level of output. In the image below, marginal cost decreases from MC1 to MC2 and the profit maximizing output increases from Q1* to Q2*: