Micro Week 5 Chapter 7 Quiz Q & A
If a purely competitive firm shuts down in the short run:
it will realize a loss equal to its total fixed costs. Explanation: When firms shut down, they do not incur the costs of production, but they still have to pay their overhead. The costs of production are their variable costs. The overhead costs are fixed. If a competitive firm shuts down in the short run they will realize a loss equal to their total fixed costs.
Refer to the graph below. The level of output at which this firm will shut down is:
0A Explanation: Profit maximizing firms produce where Marginal Revenue = Marginal Cost. In this graph, Marginal Revenue is given by the horizontal price line and Marginal Cost is depicted by the upward-sloping Nike swish Marginal Cost Curve. These two lines meet at the point corresponding to output level 0C.
Refer to the graph below. The level of output at which this firm will produce is:
0C Explanation: Profit maximizing firms produce where Marginal Revenue = Marginal Cost. In this graph, Marginal Revenue is given by the horizontal price line and Marginal Cost is depicted by the upward-sloping Nike swish Marginal Cost Curve. These two lines meet at the point corresponding to output level 0C.
Given the table below, what is the short-run profit-maximizing level of output for the firm? Output Total Revenue Total Cost 1 $4 $2 2 8 3 3 12 6 4 16 9 5 20 14
4 units Explanation: To find the short-run profit-maximizing level of output for the firm, we have to find the point at which the marginal revenue and the marginal cost are equal. Since total revenue goes up by $4 for each additional unit of production, we know that the marginal revenue = $4. When we move from 1 unit of production to 2, our cost goes up by $1; this is our marginal cost. When we move from 2 to 3 units, costs increase from $3 to $6 - marginal cost is $3. Looking at the difference between 3 and 4 units, the marginal cost is still $3. If we look at the next increase, from 4 to 5, the cost goes from $9 to $14. This is a difference of $5 which is over our marginal revenue. Since the MC is greater than the MR at 5 units, but less than MC at 4 units, we will produce 4 units of production.
Sam owns a firm that produces tomatoes in a purely competitive market. The firm's demand curve is:
A horizontal line Explanation: All firms in the purely competitive market face a horizontal demand curve. This is because market price does not depend on their individual production. A firm in this market structure can sell 1 bushel of wheat or 500,000 and they will still receive the same price for their product. Firms in these markets are price takers.
Candy Cane Corporation (CCC) produces 100,000 boxes of candy bars per year which sell for $3 a box. If variable costs are $2 per box, and it has $125,000 in fixed operating costs, in the short run the CCC should:
Keep producing as variable costs are covered Explanation: We know that in the short run, a firm will shut down only if its variable costs are not covered. We also know that if the price is above their total cost, the firm will be making a profit on each box that they sell. We are told in the problem that they make $3 per box and that the variable costs are $2 per box. This means that they will continue producing in the short run with $1 to put toward their fixed costs. We also know that their total fixed costs are $125,000. We find the average fixed cost by dividing their total fixed costs by quantity, so, AFC = $125,000 / 100,000 = $1.25 per box. Since $1.25 is greater than the $1 that they had left over after paying their variable costs, it means that they will be producing at a short-run loss.
A purely competitive firm's output is currently such that its marginal cost is $4 and marginal revenue is $5. Assuming profit maximization, the firm should:
Leave price unchanged and raise output Explanation: Since the firms MR > MC, the firm is not producing at its profit maximization point MR = MC. The firm will pull in more profit by leaving its price unchanged and increasing its output.
A firm should increase the quantity of output as long as its:
Marginal revenue is greater than its marginal cost Explanation: We make an assumption that firms in a for-profit industry seek to maximize their profits. In order to do this, they must produce the quantity of output that is consistent with profit maximization. If the Marginal Revenue (payment they receive for producing and selling the next unit of their output) is greater than the Marginal Cost (the cost of producing the next unit of their output), then the firm will put money toward its bottom line by producing that unit. Firms in for-profit industries will increase their quantity as long as the Marginal Revenue is greater than their Marginal Cost for this reason.
If a firm is a price taker, then the demand curve for the firm's product is:
Perfectly elastic Explanation: If a firm is a price taker, it means that they operate in a purely competitive market. One of the characteristics of the purely competitive market is a perfectly elastic demand curve. (p. 147)
T-Shirt Enterprises is selling in a purely competitive market. Its output is 300 units, which sell for $1 each. At this level of output, marginal cost is $1 and average variable cost is $1.50. The firm should:
Produce zero units of output Explanation: Firms will produce where Marginal Revenue equals Marginal Cost. This point of production is dual purpose. If firms are making profits, MR=MC maximizes those profits, but if a firm is losing money, the MR=MC level of production is still the best way to go because this point also minimizes losses. In the problem, we are told that the firm is operating in a purely competitive market and that the price of its product is $1. This is the Marginal Revenue. We are also told that the Marginal cost at this level of production is $1. Since these are equal, the firm has no incentive to tweak or adjust the level of production. The question now becomes should the firm produce or not. If the firm is covering its variable costs, then it should continue producing 300 units. If not, then it should produce zero units. In the problem, we are told that the firm is making $1 per unit and that the variable costs are $1.50 per unit. Since variable cost is greater than revenue, the firm should produce zero units.
Which is a feature of a purely competitive market?
Products are standardized or homogeneous Explanation: Firms in the purely competitive market are price takers, so all firms in the industry will have the same price for their goods. Entry and exit in this market structure is free, so there are no barriers to entry. Although the individual firms face a perfectly elastic demand curve, the industry's demand curve is downward sloping. That leaves the last possible answer as the correct one. In the purely competitive market, all the goods produced, marketed, and sold are homogenous (or the same).
A purely competitive firm will be willing to produce at a loss in the short run provided:
The loss is no greater than its total fixed costs Explanation: In the short run, a firm must cover its variable costs of production. If they cover their fixed costs, this is a huge bonus, but they don't have to as long as they are covering their costs to produce their output (inputs). In the short run, firms are willing to tolerate losses as long as those losses are not greater than their total fixed costs.
When demand increases, in the short run the purely competitive firm:
Will earn higher profits or experience smaller losses Explanation: When demand for a product increases in a purely competitive market, in the short run as the price goes up, firms currently in the market will earn more revenue for each unit of output that they produce. If firms are earning more revenue for each unit that they produce, they either will post higher profits or they will experience smaller losses.
In the short run the individual competitive firm's supply curve is the segment of the:
marginal cost curve lying above the average variable cost curve. Explanation: On page 156, the text states "We can conclude that the portion of the firm's marginal-cost cure lying above its average-variable-cost curve is its short-run supply curve.
The MR = MC rule applies:
to firms in all types of industries. Explanation: The MR = MC rule of profit maximization / loss minimization applies to all firms regardless of market structure. See page 150 for more on this.