Ch. 11 Costs and Profit Maximization Under Competition
On January 27, 2011, the price of Ford Motor Company stock hit an almost 10-year high at $18.79 per share. (Two years prior, in January 2009, Ford stock was trading for about a tenth of that price.) Suppose that on January 27, 2011, you owned 10,000 shares of Ford stock (a small fraction of the almost 3.8 billion shares). Suppose you offered to sell your stock for $18.85 per share, just slightly above the market price. How many shares would you sell? * a. 10,000 b. 7,300 c. 1 d. 0
0
When should the firm exit as soon as possible?
If it cannot cover its variable costs
What is the general principle of rational choice?
Ignore what you can't change and focus on what you can.
Should you produce more or less when MR< MC?
Less because you will increase your profit.
What type of industry is it when firms do not have influence over the price of their product?
Perfectly competitive
At the world price, how elastic is the demand for your oil that you want to sell?
Perfectly elastic
Revenue
Price x Quantity
When Price = Average cost how much profits will firms be making?
Zero
The greatest use of our resources occurs when: a. The price of all goods is the same b. Profits in every industry are the same c. The price of goods varies d. Profits vary by industry
b. Profits in every industry are the same
Can fixed costs be changed in the long run?
Yes Entry or exit
Short run
the period before exit or entry can occur.
Price of output is just enough to pay labor and capital at:
Zero profits
In a competitive market, sellers sell their product * a. At the world price. b. Just below the world price. c. Just above the world price. d. At a price dependent on the quantity chosen.
a. At the world price.
Fast forward 40 years: What kind of cost structure are Californian doughnut shops probably in now? * a. Constant b. Increasing c. Decreasing
a. Constant
What is the least common cost structure for an industry? * a. Costs decrease as industry output increases. b. Costs increase as industry output increases. c. Costs stay the same as industry output increases.
a. Costs decrease as industry output increases.
(Table: Barrels of Oil 2) Refer to the table. What is the marginal cost of producing the seventh barrel of oil? 90 36 126 50
Total cost of the 7th unit 126$- total cost of the 6th unit 90$=36
True or false, Maximizing profit involves knowing what to ignore and what to consider?
True
True or false, any industry that buys a large fraction of the output of an increasing cost industry is an increasing cost industry?
True
True or false, as price increases, each firm expands output by moving along its marginal cost curve?
True
True or false, rent is a fixed cost?
True
In a competitive equilibrium, firms earn ______ economic profits. positive zero negative abnormal
zero
What are two other equations that profit is equal to?
(TR/Q - TC/Q)*Q (P-AC)*Q
Examples of variable costs?
-salary payments -energy, utilities -raw materials -insurance on merchandise and employees -maintenance costs
To maximize profits, a firm in a highly competitive industry should set its price: lower than the market price. at the market price. higher than the market price. it depends: sometimes at the market price but sometimes higher or lower.
at market price.
Examples of explicit costs?
Lian spends 10,000$ to buy flowers from a wholesaler to run her flower shop. Rent for running her flower shop Electricity for running her flower shop
Are high or low fixed costs going to change the profit maximizing quantity where P=MC?
No
Given your answer to the previous question, should you sell your shares at $18.75? a. Yes b. No
No
Should you ignore the cost of rent when choosing whether or not to exit?
No
In the aforementioned disagreement on cost of one of the activities, which profession would calculate a larger cost? * a. Economist. b. Accountant.
a. Economist.
A competitive market has which of the following characteristics? * a. Lots of small-scale sellers b. Lots of small-scale buyers c. A product that is similar across sellers d. A & C only e. All of the above.
e. All of the above.
True or false, entry is the third response to increase in demand?
False, entry is the second response to increase in demand.
True or false, even when there are many sellers there are not many potential sellers?
False, even when there are many sellers there are many potential sellers.
True or false, fixed costs are irrelevant when determining to exit the firm?
False, fixed costs are relevant when determining when to exit the firm.
What type of supply curve does a constant cost industry have?
Flat horizontal supply curve
Which of the following statements is TRUE? A firm should enter an industry if average costs are less than producer surplus. Entry and exit from an industry depend on the firm's market share. High profits in an industry give entrepreneurs an incentive to enter that industry. Fixed costs fall as firms produce more output, the so called "spreading of the costs."
High profits in an industry give entrepreneurs an incentive to enter that industry.
Which of the following factors cause markets to be dynamic? I-Changes in tastes II-Changes in technology III-New idea development
I, II and III
A perfectly competitive industry exists under which of the following conditions? I. The product sold is similar across firms. II. There are many sellers, each small relative to the total market. III. There are many sellers, each with total assets less than $2 million. IV. The threat of competition exists from potential sellers that have not yet entered the market. I and II only I, III, and IV only I, II, and IV only I, II, and III only
I, II and IV only
What do you do when calculating the economic profit?
Include the opportunity cost of renting what you own to another firm.
When an increase in demand hits the domain name registrar industry in the short run, what happens to the price?
Increases
Any industry where it is difficult to duplicate inputs is:
Increasing cost industry
Costs increase with greater industry output and this generates an upward-slopping supply curve.
Increasing cost industry
True or false, any industry that buys a large fraction of the output of an increasing cost industry is:
Increasing cost industry
(Table: Barrels of Oil 2) Refer to the table. The maximum profit available to the company is: $266. $210. $184. $224.
MAXIMUM= MR=MC Find where marginal revenue = marginal cost: Unit 8 TR=400, TC= 176 subtract TR-TC= 224
Marginal revenue formula
MR= change in total revenue/ change in quantity
Profit is maximized by producing until:
MR=MC
When does profit maximization occur?
MR=MC
What does marginal revenue = to for a firm in a competitive industry?
MR=Price
True or false, you should ignore fixed costs when deciding what quantity to produce?
True
What are the columns on the periodic table called?
Units Total Revenue (P*Q) Total Cost Profit (TR-TC) Marginal Revenue (P) or (^in TR/^ Q) Marginal Cost ( ^TC/^Q) Change in profit (go to profit)
What type of supply curve does an increasing cost industry have?
Upward sloped
Average variable cost curve
VC/Q
Which costs vary with output?
Variable
Imagine that you are the owner of a stripper oil well and that you want to maximize your profit. What three questions present themselves?
What price to set? What quantity to produce? When to enter or exit the industry?
When are there no incentives to enter or exit the industry?
When Price = Average Cost
At this point in the story, what sort of cost industry (constant, increasing, or decreasing) would you consider doughnut shops owned by Cambodians to be? * a. Constant b. Increasing c. Decreasing
c. Decreasing
Which type of cost is dependent on the amount of quantity produced by a firm? * a. fixed costs b. variable costs c. sunk costs d. none of the above
b. variable costs
A competitive firm maximizes profit by choosing a level of output where the world price is equal to the firm's * a. Marginal revolution. b. Marginal revenue. c. Marginal cost. d. Average cost. e. Fixed costs. f. Variable costs.
c. Marginal cost.
Where can we see the average variable cost on the graph?
Below AC and above AVC
which industry is more uncommon?
Decreasing cost industry
Total cost=
fixed cost + variable cost
Which costs do not vary with output?
Fixed
A cost that does not require spending money?
Implicit costs
Accounting profits
total revenue - explicit costs
Profit =
total revenue - total cost
Which industry is it easiest to expand output without raising costs?
Constant cost industry
When is there no entry or exit for a firm?
P=AC profits are 0
______________is small relative to its input markets, so when the industry ___________expands, it does not push up the price of its inputs and thus industry costs do not____________.
Constant cost industry Expands Increase
Suppose instead that on January 27, 2011, you wanted to sell your 10,000 shares of Ford stock but you reduced your asking price to $18.75 per share? How many shares would you sell? * a. 10,000 b. 7,300 c. 1 d. 0
10,000
If Tom sells 500 sandwiches for $7 and has an average cost of $5, what is his profit? $3,500 $500 $2,500 $1,000
1000
How many columns are in the periodic table
7
About ____________barrels are bought and sold every day.
82mil
Fill in the blank: Even if profit is negative, if revenues are ______ variable costs, then it's best to stay open in the short run. a. > b.<
>
Long run
After all entries and exits has occurred.
Once the cluster of the decreasing cost industry is established _________or__________increasing costs are the norm.
Constant Increasing
Costs decrease with greater industry output and this generates a downward-sloping supply curve.
Decreasing cost industry
Fixed cost
Does not vary with the quantity produced
What type of supply curve does a decreasing cost industry have?
Downward sloped supply curve.
Because average costs don't change much when the industry expands or contracts the price of domain name registration doesn't change much when the industry:
Expands or contracts so the long run supply curve is very elastic.
Total costs cannot be minimized if firms:
Face different prices
True or false, you cannot sell all your oil at the market price?
False, you can sell all your oil at the market price.
Why is the distinction between accounting profit and economic profit so important?
Firms prefer to maximize economic profit.
What type of elasticity does the long run supply curve of the domain name registrar industry?
Flat Very elastic
What are the conditions for a perfectly competitive industry?
Many buyers and sellers, each small relative to the total market Product sold is similar across sellers Many potential sellers
Each firm expands output by moving along which curve?
Marginal cost curve
If you want to maximize your profit, at what price do you want to sell your oil?
Market
In a competitive market, the amount of a good produced is such that social surplus is:
Maximized
Marginal revenue = Marginal cost
Maximum profit
When should the firm shut down immediately?
TR<TC
You've been hired as a management consultant to WaffleCo, a maker of generic-brand frozen waffles. They're each trying to figure out if they should produce a little more output or a little bit less in order to maximize their profits. The firms all have typical marginal cost curves: They rise as the firm produces more. Your staff did all the hard work for you of figuring out the price of the firm's output is $4 per box and the marginal cost of producing one more unit of output is $2 per box at its current level of output. However, they forgot to collect data on how much the firm is actually producing at the moment. Fortunately, that doesn't matter. In your final report, you need to decide if the firm should produce more, less, or stay at the current output level. What do you recommend? a. Produce more. b. Less
More
If you spend 5000$ to drill your oil well, what influence should that cost have on what quantity you produced?
None. The cost is a sunk cost.
What is the economic problem with the monopolistic industries?
Not enough inputs move into the industry leaving output too low.
When do firms have a lot of influence on the product of their price?
Not many sellers Not many potential sellers
Average Variable Cost
P < VC/Q
In a constant cost industry, P = AC = $20. Which sequence of events follows an increase in demand? P > AC, firms make an economic profit, existing firms expand output, new firms enter the industry, the short-run supply curve shifts right, price falls until profits return to $0 P > AC, firms make an economic profit, existing firms expand output, new firms enter the industry, the short-run supply curve shifts left, price falls until profits return to $0 P = AC, firms make no economic profit, existing firms leave output unchanged, new firms enter the industry, profits remain normal, P = AC = $20 P < AC, firms suffer an economic loss, existing firms reduce output, new firms enter the industry, the short-run supply curve shifts right, price falls until profits exceed $0
P > AC, firms make an economic profit, existing firms expand output, new firms enter the industry, the short-run supply curve shifts right, price falls until profits return to $0
For a competir firm, profit maximizing quantity in a graph is where:
P=MC
Where can we find the profit-maximizing quantity for a competitive firm?
P=MC
Examples of constant cost industries?
Pencils Rutabegas Domain name registration
What condition is necessary in a constant cost industry? Prices of the industry's inputs decline as the industry expands. Prices of the industry's inputs do not change as the industry expands. Prices of the industry's inputs rise as the industry expands. There are barriers that prevent new firms from entering such an industry.
Prices of the industry's inputs do not change as the industry expands.
What happens when the price for domain name registration is quickly driven down to the average cost of managing and assigning a domain name?
Profits are quickly driven to normal levels.
If the demand for computers were to increase in silicone valley today, the price of computers will ________not________.
Rice not fall
What is the price per barrel of oil if you decide to sell 2, 7 or 10 per day?
Same as the market price
In the __________the fixed costs are an expense but not an economic opportunity cost so they should be ignored.
Short
When should the owner of an oil well keep producing additional barrels of oil?
So long as the revenue from producing an additional barrel exceeds the cost of producing an additional barrel. MR>MC
What type of costs need to be ignored in the short run?
Sunk Fixed
What is the difference between fixed costs and sunk costs?
Sunk costs can never be changed Fixed costs can In the long run but not in the short.
What point on the Average cost curve can you find the lowest price per barrel where a firm can make a profit?
The lowest point on the Average Cost curve.
Are all examples of implicit costs.
The opportunity to earn 7000$ as a patent attorney which is a cost of running a flower shop if you choose one over the other.
Economic profits
Total revenue -total costs, including implicit opportunity costs.
True or false, at some point, marginal cost must increase?
True
True or false, generalizing a perfectly elastic demand curve for the firm output is a reasonable approximation when the product being sold is similar across different firms and there are many buyers and sellers, each small relative to the total market?
True
True or false, the competitive firm is a price taker because the price stays the same whether you decided to sell a different quantity of barrels per day?
True
True or false, you cannot sell any oil at the price above the market?
True
Could firm costs decrease as the industry expands, creating a decreasing cost industry with a downward-sloping supply curve?
YES
What are normal profits?
Zero profits
Sunk cost
a cost that has already been paid and cannot be recovered
Explicit cost
a cost that involves spending money
Whenever money is used to purchase capital, interest costs are incurred. Sometimes those costs are explicit—like when Alex borrowed the money from the bank—and sometimes those costs are implicit— like when Tyler had to forgo the interest he could have earned had he left his funds in a savings account. If an economist and accountant calculated Alex and Tyler's costs, for whom would they have identical numbers and for whom would the numbers differ? * a. Economist and accountant would agree on Alex's costs and disagree on Tyler's. b. Economist and accountant would agree on Tyler's costs and disagree on Alex's.
a. Economist and accountant would agree on Alex's costs and disagree on Tyler's.
We mentioned that carpet manufacturing looks like a decreasing cost industry. In American homes, carpets are much less popular than they were in the 1960s and 1970s, when "wall-to-wall carpeting" was fashionable in homes. Suppose that carpeting became even less popular than it is today: What would this fall in demand probably do to the price of carpet in the long run? * a. Increase carpet prices b. Decrease carpet prices c. No change to carpet prices
a. Increase carpet prices
In the ancient Western world, incense was one of the first commodities transported long distances. It grew only in the south of the Arabian Peninsula (modern-day Yemen, known then as Arabia Felix) and was transported by camel to Alexandria and the Mediterranean civilizations, notably the Roman Republic. As the republic expanded into a richer and larger empire, the demand for incense grew and planters in Arabia added a second and then a third annual crop (though this incense was not as high of a quality). Cultivation also crossed to the Horn of Africa even though such fields were farther away from Rome. The fact that additional annual crops were of lower quality indicates that this industry has * a. Increasing costs. b. Decreasing costs. c. Constant costs. d. Indeterminate from the given information.
a. Increasing costs.
It's more costly to grow incense in Eastern Africa than in Arabia Felix. Which region would you expect to see more incense grown in? * a. Eastern Africa b. Arabia Felix
b. Arabia Felix
If this is an increasing cost industry instead, will the long-run price of pajamas rise by more than $2 or less? (Hint: The long-run supply curve will be shaped just like an ordinary supply curve. If you treat this like a $2 tax per pair, you'll get the right answer.) * a. The price of pajamas increases by more than $2. b. The price of pajamas increases by less than $2. c. The price of pajamas increases by exactly $2.
b. The price of pajamas increases by less than $2.
The economic definition of profit differs from the accounting definition of profit in that the economic definition includes * a. Fixed costs. b. Variable costs. c. Opportunity costs. d. Sunk costs. e. None of the above.
c. Opportunity costs.
As Ngoy started hiring more Cambodian refugees to work in his donut shop, this made it more likely that * a. Competition from other doughnut shop owners would increase. b. Ngoy's fixed costs decreased. c. Other Cambodians would open donut shops.
c. Other Cambodians would open donut shops.
In the competitive children's pajama industry, a new government safety regulation raises the average cost of children's pajamas by $2 per pair. If this is a constant cost industry, then in the long run, what exactly happens to the price of children's pajamas? * a. The price of pajamas increases by more than $2 b. The price of pajamas increases by less than $2 c. The price of pajamas increases by exactly $2
c. The price of pajamas increases by exactly $2
Marginal cost
change in total cost / change in quantity
Constant cost industry:
costs do not change with changes in output (flat supply curve) costs
Which of these equations describes the invisible hand property 1? a. P=AC b. P=MR c. (p-AC)Q d. P=MC1=MC2...MCn
d.
The oil industry is an increasing cost industry because: All of these statements are correct. people buy more oil at lower prices. because oil is a necessity good. expanding output requires firms to use more expensive production methods to find and extract oil from less desirable locations.
expanding output requires firms to use more expensive production methods to find and extract oil from less desirable locations.
Total cost
fixed costs + variable costs
In competitive markets, the demand curve faced by the individual firm is: equal to the market demand curve. perfectly elastic. downward sloping. perfectly inelastic.
perfectly elastic.
Difference between total revenue and total cost?
profit
Marginal revenue
the change in total revenue from an additional unit sold
Average cost
the total cost divided by the quantity produced. AC=TC/Q
If P>AC in a given industry, then:
there are too few resources
