Perfect Competition Homework
accounting profit
A firm's revenues minus all its explicit costs
The figure to the right represents the cost structure for a perfectly competitive wheat farmer with her average total cost (ATC) curve and marginal cost (MC) curve. At what market price will the wheat farmer break even? The wheat farmer will break even at a price of ______ per bushel. (Enter your response as an integer.) If the market price for wheat were indeed $5 per bushel, should the wheat farmer exit the industry in the long run? In the long run, the wheat farmer A. should continue to produce wheat because breaking even is as high a return as she could earn elsewhere. B. should exit the industry because economic profit is negative when breaking even. C. should exit the industry because breaking even does not account for implicit opportunity costs. D. should continue to produce wheat because she will still have to pay her fixed costs of production even if she exits the industry. E. should exit the industry because accounting profit equals zero when breaking even.
5; A. should continue to produce wheat because breaking even is as high a return as she could earn elsewhere. Part 1: Break-even point: A firm is breaking even when its total cost equals its total revenue. Since perfectly competitive firms produce where price equals marginal cost, this occurs when price equals the lowest point on the average total cost curve (where the marginal cost curve intersects the average total cost curve). Therefore, a firm is breaking even when the market price is $5 per bushel of wheat. Part 2: Economic profit: A firm's revenues minus all its costs, implicit and explicit. Since accounting profit generally only includes explicit costs, breaking even corresponds to positive accounting profit. When breaking even, the wheat farmer should continue to produce in the long run because this is as high a return as she could earn elsewhere. Because economic profit takes into account all of the wheat farmer's costs, she should continue to produce because she can cover all her implicit opportunity costs.
price taker
A buyer or seller that is unable to affect the market price. Because farmer Smith is a price taker, he can sell as many baskets of apples as he chooses at the market price—but he can't sell any apples at all at a higher price.
economic profit
A firm's revenues minus all its costs, implicit and explicit.
What determines entry and exit of firms in a perfectly competitive industry in the long run? In a perfectly competitive industry in the long run, A. new firms will enter if existing firms are making a profit and existing firms will exit if they are experiencing losses. B. new firms will enter if existing firms are making a profit and existing firms will exit if they are breaking even or experiencing losses. C. new firms will enter if price is above the shutdown point and existing firms will exit if price is below the shutdown point. D. new firms will enter if market demand exceeds market supply and existing firms will exit if market supply exceeds market demand. E. new firms cannot enter the market due to barriers but existing firms will exit if they are experiencing losses.
A. new firms will enter if existing firms are making a profit and existing firms will exit if they are experiencing losses. Entry and exit decisions: Profits and losses provide signals to firms that lead to entry and exit in the long run. For example, unless a firm can cover all its costs, it will shut down and exit the industry. More precisely, new firms will enter if existing firms are making a profit and existing firms will exit if they are experiencing losses. Next Question
Average revenue (AR)
Average revenue is total revenue divided by the quantity of the product sold: AR=TR/Q.
Which of the following is an expression of profit for a perfectly competitive firm? Profit for a perfectly competitive firm can be expressed as A. Profit=P−MC, where P is price and MC is marginal cost. B. Profit=(P×Q)−(ATC×Q), where P is price, Q is output, and ATC is average total cost. C. Profit=(P−TC)×Q, where P is price, Q is output, and TC is total cost. D. Profit=P×Q, where P is price and Q is output. E. Profit=P−ATC, where P is price and ATC is average total cost.
B. Profit=(P×Q)−(ATC×Q), where P is price, Q is output, and ATC is average total cost. Because Profit=TR−TC, and TR is price (P) times quantity (Q), we can write the following: 1. Profit=TR−TC or 2. Profit=(P×Q)−TC. If we divide both sides of this equation by Q, we have: 3. Profit/Q=(P×Q)/Q−TC/Q, or 4. Profit/Q=P−ATC, where ATC is average total cost, because TC/Q equals ATC. This expression tells us that profit per unit (or average profit) equals price minus average total cost. We obtain an expression for the relationship between total profit and average total cost by multiplying by Q: Profit=(P−ATC)×Q.
break even point
Break-even point: A firm is breaking even when its total cost equals its total revenue.
What conditions make a market perfectly competitive? A market is perfectly competitive if A. it has many buyers and a few sellers, all of whom are selling differentiated products, with no barriers to new firms entering the market. B. it has many buyers and a few sellers, all of whom are selling identical products, with barriers to new firms entering the market. C. it has many buyers and many sellers, all of whom are selling identical products, with no barriers to new firms entering the market. D. it has many buyers and one firm, which produces a product with no close substitutes, with barriers to new firms entering the market. E. it has many buyers and many sellers, all of whom are selling differentiated products, with no barriers to new firms entering the market.
C. it has many buyers and many sellers, all of whom are selling identical products, with no barriers to new firms entering the market. Perfectly competitive markets A market that meets the following conditions: 1. Many buyers and sellers. Each individual buyer and seller is small relative to the entire market, and, as a result, cannot affect the market price. 2. All firms sell identical products. There can be no verifiable difference between the goods and services sold under perfect competition. 3. There are no barriers to entry into the market.
What is the supply curve for a perfectly competitive firm in the short run? The supply curve for a firm in a perfectly competitive market in the short run is A. that firm's marginal revenue curve for prices at or above average fixed cost. B. that firm's marginal cost curve. C. that firm's marginal cost curve for prices at or above average total cost. D. a horizontal line equal to the market price. E. that firm's marginal cost curve for prices at or above average variable cost.
E. that firm's marginal cost curve for prices at or above average variable cost. The supply curve for a firm: Tells us how many units of a product the firm is willing to sell at any given price. The marginal cost curve for a firm in a perfectly competitive market tells us the same thing. The firm will produce at the level of output where price equals marginal cost. Therefore, a perfectly competitive firm's marginal cost curve is also its supply curve. However, if a firm is experiencing losses, it will shut down if its total revenue is less than its variable cost. That is, if price drops below average variable cost, the firm will have a smaller loss if it shuts down and produces no output. So, the firm's marginal cost curve is its supply curve only for prices at or above average variable cost.
How should firms in perfectly competitive markets decide how much to produce? Perfectly competitive firms should produce the quantity where A. the market price is as low as possible. B. their individual price is as high as possible. C. the difference between explicit costs and implicit costs is as large as possible. D. their individual price is equal to the market price. E. the difference between total revenue and total cost is as large as possible.
E. the difference between total revenue and total cost is as large as possible. Perfectly competitive firms cannot control price and are consequently price takers. Economists assume that the objective of such firms is to maximize profit (total revenue minus total cost). Therefore, to maximize profit, a firm should produce the quantity of output where the difference between total revenue and total cost is as large as possible.
economic profit
Economic profit: A firm's revenues minus all its costs, implicit and explicit. Since accounting profit generally only includes explicit costs, breaking even corresponds to positive accounting profit.
Suppose a farmer in Georgia begins to grow peaches. He uses $1,000,000 in savings to purchase land, he rents equipment for $80,000 a year, and he pays workers $140,000 in wages. In return, he produces 100,000 baskets of peaches per year, which sell for $3.00 each. Suppose the interest rate on savings is 1 percent and that the farmer could otherwise have earned $25,000 as a shoe salesman. What is the farmer's economic profit? What is the farmer's accounting profit?
Economic profit: A firm's revenues minus all its costs, implicit and explicit. Total revenue (TR): TR=P×Q. The farmer's total revenue is $300,000: ($3.00 per basket of peaches multiplied by 100,000 baskets of peaches). The farmer's explicit costs are $80,000 in rent and $140,000 in wages. The farmer's implicit costs are $25,000 in foregone salary and $10,000 in foregone interest (from $1,000,000 multiplied by the 1 percent interest rate). Therefore, total costs are $255,000, and economic profit is $45,000 ($300,000 in revenue minus $255,000 in costs). Accounting profit: A firm's revenues minus all its explicit costs. The farmer's total revenue is $300,000: ($3.00 per basket of peaches multiplied by 100,000 baskets of peaches). The farmer's explicit costs are $80,000 in rent and $140,000 in wages. Therefore, accounting profit is $80,000, from $300,000 in revenue minus $220,000 in explicit costs.
perfect competition
In perfectly competitive markets, firms are price takers—they accept the market price as given, but not fixed. That is, events in the market (a change in demand or a change in supply) might change market price, but the individual buyer or seller is unable to affect the market price.
marginal revenue
Marginal revenue is the change in total revenue from selling one more unit of a product. More formally, it is the change in total revenue that results from a one-unit change in quantity, or: MR=ΔTR/ΔQ.
The figure to the right illustrates the average total cost (ATC) and marginal cost (MC) curves for an apple farmer. Assume the market for apples is perfectly competitive. If the market price for apples is $66.00 per crate, then what will be this apple farmer's profit? Use the rectangle drawing tool to shade in the apple farmer's profit. Label this shaded area 'Profit'. Carefully follow the instructions above, and only draw the required objects.
Profit maximization in a perfectly competitive market: A firm maximizes profit at the level of output at which marginal revenue, (MR), equals marginal cost, (MC). In perfectly competitive markets, marginal revenue equals the market price, (P). If the market price (P), of apples is $66.00 per crate, then the apple farmer will produce 7 hundred crates of apples, where (MR) = (MC) = (P). Profit per unit of output: P−ATC = profit per unit of output. Total profit: Total profit equals profit per unit multiplied by the number of units produced: (P−ATC)×Q. Total profit is represented by the area of a rectangle which has a height equal to (P−ATC) and a width equal to Q, where this apple farmer's average total cost (of producing 7 hundred crates) is $30.00 per crate.
entry and exit decisions
Profits and losses provide signals to firms that lead to entry and exit in the long run.
total revenue
TR= P x Q
supply curve of a firm
Tells us how many units of a product the firm is willing to sell at any given price. The marginal cost curve for a firm in a perfectly competitive market tells us the same thing.
total revenue
Total revenue (TR): TR=P×Q.
The figure represents the cost structure for a perfectly competitive firm with its average total cost (ATC) curve, average variable (AVC) curve, and marginal cost (MC) curve. Suppose the market price is $10.00 per unit. Will firms enter or exit the industry in the long run? If market price is $10.00, then firms will ______ the market in the long run. What effect will firms exiting have on the market price? When firms exit, A. the average total cost of production will increase, increasing price. B. market supply will increase, increasing price. C. market supply will decrease, increasing price. Your answer is correct. D. the marginal cost of production will increase, increasing price. E. market demand will decrease, increasing price.
exit; C. market supply will decrease, increasing price. Your answer is correct. Entry and exit decisions: In the long run: If price is greater than average total cost (P>ATC), then new firms will enter the market. If price is less than average total cost (P<ATC), then existing firms will exit. The price, $10.00, is less than average total cost, so firms will exit. part 2 Entry and exit decisions: In the long run: If P > ATC, then new firms will enter the market. If new firms enter, then the market supply curve will shift to the right and decrease the market price. If P < ATC, then existing firms will exit. If existing firms exit, then the market supply curve will shift to the left, and increase the market price. Since firms are exiting the industry, market supply will decrease, increasing the market price.
The figure to the right represents the cost structure for a perfectly competitive firm with its average total cost (ATC) curve, average variable (AVC) curve, and marginal cost (MC) curve. Fixed costs are $50.00. Suppose the market price is $23.00 per unit. Characterize the firm's profit. If the firm produces output, then it will ________ Should the firm instead shut down in the short run? In the short run, the firm should A. continue to produce because price is greater than average fixed cost. B. shut down because price is less than fixed costs. C. continue to produce because price is greater than average variable cost. D. shut down because price is greater than average variable cost. E. shut down because price is less than average total cost.
experience losses; C. continue to produce because price is greater than average variable cost. Part 1: Production decision in the short run: If the firm produces, then it will produce an output level where price equals marginal cost. If price is greater than average total cost, then the firm will make a profit. If price is equal to average total cost, then the firm will break even. If price is less than average total cost, then the firm will experience losses. The $23.00 price is less than the average total cost of production, so the firm will experience losses. part 2: Shut-down point in the short run: In the short run, if price is greater than average variable cost, then the firm should continue to produce (because the firm would lose an amount less than fixed costs by shutting down). However, if price is less than average variable cost, then the firm should stop production by shutting down. The $23.00 price is greater than average variable cost, so the firm should continue to produce.
The figure on the left represents the cost structure for a perfectly competitive wheat farmer with her average total cost (ATC) curve and marginal cost (MC) curve-this firm's cost curves are representative of most firms in the market. The figure on the right represents the market for wheat. part 1 Characterize profits for the firms in this industry. Firms in this market are currently; part 2 What will be the market price at the long-run competitive equilibrium? The long-run equilibrium price will be part 3 In long-run, firms will ________ the market until the marginal firm is earning ____________ .
making a profit; $4; enter, zero economic profit Part 1: Profits and losses: If P > ATC, then a firm will make a profit. If P = ATC, then a firm will break even. If P < ATC, then a firm will experience losses. The market price is initially $7.00, where market supply equals market demand. When farmers produce the profit-maximizing quantity of wheat, price is greater than average total cost, so firms are making a profit. part 2: Long-run competitive equilibrium: The situation in which the entry and exit of firms has resulted in the typical firm breaking even. The long-run equilibrium market price is at a level equal to the minimum point on the typical firm's average total cost curve. Therefore, the long-run equilibrium price will be $4.00 per bushel of wheat.
Suppose Farmer Smith grows apples. The enitre market for apples is shown in the figure below. Assume the market for apples is perfectly competitive. Use the line drawing tool to draw the demand curve for farmer Smith's apples. Label this line 'Demand for Smith apples'.
Therefore, the demand curve for his apples has an unusual shape: It is a horizontal line at the market price for apples, which is $10.00 per basket.