CH 8 HW

Consider the perfectly competitive market for copper. Assume that, regardless of how many firms are in the industry, every firm in the industry is identical and faces the marginal cost (MCMC), average total cost (ATCATC), and average variable cost (AVCAVC) curves shown on the following graph. The following diagram shows the market demand for copper. Use the orange points (square symbol) to plot the initial short-run industry supply curve when there are 20 firms in the market. (Hint: You can disregard the portion of the supply curve that corresponds to prices where there is no output since this is the industry supply curve.) Next, use the purple points (diamond symbol) to plot the short-run industry supply curve when there are 40 firms. Finally, use the green points (triangle symbol) to plot the short-run industry supply curve when there are 60 firms. If there were 60 firms in this market, the short-run equilibrium price of copper would be $40 per pound. At that price, firms in this industry would operate at a loss . Therefore, in the long run, firms would exit the copper market. Because you know that perfectly competitive firms earn zero economic profit in the long run, you know the long-run equilibrium price must be $52 per pound. From the graph, you can see that this means there will be 20 firms operating in the copper industry in long-run equilibrium.

(Graph) In the short run, a perfectly competitive firm will produce as long as the market price is equal to or greater than the shutdown price of $16. For prices below $16, firms in this industry cannot cover their variable costs and will therefore shut down, that is, not produce. For prices above $16, the industry's supply curve is the horizontal summation of all firms' marginal cost curves. For example, at a price of $16, each firm will produce 12,000 pounds of copper. Therefore, 20 firms would supply a total of 12,000 pounds per firm×20 firms=240,000 pounds12,000 pounds per firm×20 firms=240,000 pounds at that price, 40 firms would supply a total of 12,000 pounds per firm×40 firms=480,000 pounds12,000 pounds per firm×40 firms=480,000 pounds, and 60 firms would supply a total of 12,000 pounds per firm×60 firms=720,000 pounds12,000 pounds per firm×60 firms=720,000 pounds. To construct the rest of each supply curve, you can perform similar calculations at prices of $40, $52, $64, and $80 per pound. Filled out to the left The short-run industry supply curve with 60 firms intersects the demand curve at a price of $40 per pound of copper. This corresponds to a point on the marginal cost curve that is below each firm's average total cost curve. Therefore, in the short run, firms in this industry are able to cover only variable costs and not all fixed costs; thus, they earn a negative profit. The fact that firms in this industry are earning a negative profit means that, as time goes on, firms in the industry will exit in search of better opportunities in other markets rather than continue to pay the fixed cost, because fixed costs are optional in the long run but not the short run. As firms leave the market, the market price will rise until it is at the point at which firms earn zero profit. At this point, firms in this industry will have no incentive to exit, and firms not in the industry will have no incentive to enter, so the industry will be in long-run equilibrium. Filled out to the left In the long run, firms will enter the industry if they can earn a positive profit, and firms will exit the industry if they are running at a loss. In long-run equilibrium, firms have no incentive to either enter or exit the industry, which means that firms in the industry must be earning zero profit. Total profit—the difference between total revenue and total cost—can be calculated as the difference between the price and average total cost times the quantity of output: (P−ATC)×QP−ATC×Q. Because average profit per unit is measured by P−ATCP−ATC, and because perfectly competitive firms produce at the point at which price equals marginal cost (MCMC), firms earn zero profit when P=ATC=MCP=ATC=MC. As seen in the preceding cost-curve graph, this occurs at a price of $52 per pound. Note also that price equals ATC at the point where ATC reaches a minimum. The level of production corresponding to the lowest average total cost is called the firm's efficient scale; therefore, in the long-run equilibrium of a perfectly competitive market with free entry and exit, firms must be operating at their efficient scale. From the previous graph, you can see that the short-run equilibrium price is $52 per pound if there are 20 firms in the copper industry, indicating that $52 per pound is the long-run price. Therefore, if there are 20 firms in the industry, firms will have no incentive to enter or exit the market.

Consider the perfectly competitive market for steel. Assume that, regardless of how many firms are in the industry, every firm in the industry is identical and faces the marginal cost (MCMC), average total cost (ATCATC), and average variable cost (AVCAVC) curves shown on the following graph. The following diagram shows the market demand for steel. Use the orange points (square symbol) to plot the initial short-run industry supply curve when there are 10 firms in the market. (Hint: You can disregard the portion of the supply curve that corresponds to prices where there is no output since this is the industry supply curve.) Next, use the purple points (diamond symbol) to plot the short-run industry supply curve when there are 20 firms. Finally, use the green points (triangle symbol) to plot the short-run industry supply curve when there are 30 firms. If there were 20 firms in this market, the short-run equilibrium price of steel would be $52 per ton. At that price, firms in this industry would earn a positive profit . Therefore, in the long run, firms would enter the steel market. Because you know that perfectly competitive firms earn zero economic profit in the long run, you know the long-run equilibrium price must be $44 per ton. From the graph, you can see that this means there will be 30 firms operating in the steel industry in long-run equilibrium.

(Graph) In the short run, a perfectly competitive firm will produce as long as the market price is equal to or greater than the shutdown price of $20. For prices below $20, firms in this industry cannot cover their variable costs and will therefore shut down, that is, not produce. For prices above $20, the industry's supply curve is the horizontal summation of all firms' marginal cost curves. For example, at a price of $20, each firm will produce 24,000 tons of steel. Therefore, 10 firms would supply a total of 24,000 tons per firm×10 firms=240,000 tons24,000 tons per firm×10 firms=240,000 tons at that price, 20 firms would supply a total of 24,000 tons per firm×20 firms=480,000 tons24,000 tons per firm×20 firms=480,000 tons, and 30 firms would supply a total of 24,000 tons per firm×30 firms=720,000 tons24,000 tons per firm×30 firms=720,000 tons. To construct the rest of each supply curve, you can perform similar calculations at prices of $36, $44, $52, and $72 per ton. Filled out to the left The short-run industry supply curve with 20 firms intersects the demand curve at a price of $52 per ton of steel. This corresponds to a point on the marginal cost curve that is above each firm's average total cost curve. Therefore, in the short run, firms in this industry are more than able to cover fixed costs and variable costs; thus, they earn a positive profit. The fact that firms in this industry are earning positive profit will encourage entry into the market. This entry by new firms will drive the market price down until firms earn zero profit. At this point, firms not in the industry will have no incentive to enter, and firms in the industry will have no incentive to exit, so the industry will be in long-run equilibrium. Filled out to the left In the long run, firms will enter the industry if they can earn a positive profit, and firms will exit the industry if they are running at a loss. In long-run equilibrium, firms have no incentive to either enter or exit the industry, which means that firms in the industry must be earning zero profit. Total profit—the difference between total revenue and total cost—can be calculated as the difference between the price and average total cost times the quantity of output: (P−ATC)×QP−ATC×Q. Because average profit per unit is measured by P−ATCP−ATC, and because perfectly competitive firms produce at the point at which price equals marginal cost (MCMC), firms earn zero profit when P=ATC=MCP=ATC=MC. As seen in the preceding cost-curve graph, this occurs at a price of $44 per ton. Note also that price equals ATC at the point where ATC reaches a minimum. The level of production corresponding to the lowest average total cost is called the firm's efficient scale; therefore, in the long-run equilibrium of a perfectly competitive market with free entry and exit, firms must be operating at their efficient scale. From the previous graph, you can see that the short-run equilibrium price is $44 per ton if there are 30 firms in the steel industry, indicating that $44 per ton is the long-run price. Therefore, if there are 30 firms in the industry, firms will have no incentive to enter or exit the market.

Consider a perfectly competitive market for wheat in Denver. There are 110 firms in the industry, each of which has the cost curves shown on the following graph: The following graph shows the market demand for wheat. 1. Use the orange points (square symbol) to plot the short-run industry supply curve for the wheat industry. Specifically, place an orange point at the lowest point of the supply curve and another orange point at the highest point of the supply curve. (Hint: You can disregard the portion of the supply curve that corresponds to prices where there is no output, since this is the industry supply curve. Plot your points in the order in which you would like them connected. Line segments will connect the points automatically.)2. Place the black point (plus symbol) on the graph to indicate the short-run equilibrium price and quantity in this market. (Note: Dashed drop lines will automatically extend to both axes.) At the current short-run market price, firms will_____ in the short run. In the long run,_____________________ given the current market price.

(graph) In the short run, the individual supply curve for a firm is the portion of the marginal cost curve that corresponds to prices greater than or equal to the shutdown price of 25¢ (the price at which a firm is indifferent between producing and shutting down). At prices below 25¢, firms will not produce in the short run. At 25¢, firms will produce a total of 30,000 bushels of wheat per firm×110 firms=3,300,000 bushels of wheat30,000 bushels of wheat per firm×110 firms=3,300,000 bushels of wheat. Therefore, (3300, 25) is the lowest point on the short-run industry supply curve. Similarly, at 85¢ per bushel, firms will produce a total of 50,000 bushels of wheat per firm×110 firms=5,500,000 bushels of wheat50,000 bushels of wheat per firm×110 firms=5,500,000 bushels of wheat. Therefore, (5500, 85) is the highest point on the short-run industry supply curve. The short-run equilibrium price and quantity in this market occurs at the intersection of the market demand and market supply curves, which occurs at a price of 70¢ and quantity of 4,950,000 bushels of wheat in this case. produce, some firms will enter the market The supply and demand curves intersect at a price of 70¢ per bushel. This corresponds to a point on the MC curve that is above each firm's ATC curve. Therefore, in the short run, firms in this industry are able to cover fixed costs and variable costs and to make a positive profit. The fact that firms in this industry are earning positive profit will encourage entry into the market. This entry by new firms will drive the market price down until firms earn zero profit. At this point, firms not in the industry will have no incentive to enter, and firms in this industry will have no incentive to leave, so the industry will be in long-run equilibrium.

Consider a perfectly competitive market for wheat in San Francisco. There are 90 firms in the industry, each of which has the cost curves shown on the following graph: The following graph shows the market demand for wheat. 1. Use the orange points (square symbol) to plot the short-run industry supply curve for the wheat industry. Specifically, place an orange point at the lowest point of the supply curve and another orange point at the highest point of the supply curve. (Hint: You can disregard the portion of the supply curve that corresponds to prices where there is no output, since this is the industry supply curve. Plot your points in the order in which you would like them connected. Line segments will connect the points automatically.)2. Place the black point (plus symbol) on the graph to indicate the short-run equilibrium price and quantity in this market. (Note: Dashed drop lines will automatically extend to both axes.) At the current short-run market price, firms will______ in the short run. In the long run,_____________ the market given the current market price.

(graph) In the short run, the individual supply curve for a firm is the portion of the marginal cost curve that corresponds to prices greater than or equal to the shutdown price of 25¢ (the price at which a firm is indifferent between producing and shutting down). At prices below 25¢, firms will not produce in the short run. At 25¢, firms will produce a total of 30,000 bushels of wheat per firm×90 firms=2,700,000 bushels of wheat30,000 bushels of wheat per firm×90 firms=2,700,000 bushels of wheat. Therefore, (2700, 25) is the lowest point on the short-run industry supply curve. Similarly, at 85¢ per bushel, firms will produce a total of 50,000 bushels of wheat per firm×90 firms=4,500,000 bushels of wheat50,000 bushels of wheat per firm×90 firms=4,500,000 bushels of wheat. Therefore, (4500, 85) is the highest point on the short-run industry supply curve. The short-run equilibrium price and quantity in this market occurs at the intersection of the market demand and market supply curves, which occurs at a price of 40¢ and quantity of 3,150,000 bushels of wheat in this case. produce, some firms will exit The supply and demand curves intersect at a price of 40¢ per bushel. This corresponds to a point on the MC curve that is below each firm's ATC curve but above its AVC curve. Therefore, in the short run, firms in this industry are able to cover their variable costs but not their fixed costs. Therefore, firms are suffering a loss but will produce positive output in the short run. The fact that firms in this industry are earning negative profit means that as time goes on, firms in the industry will exit in search of better opportunities in other markets, rather than pay the fixed cost. This is because fixed costs are optional in the long run but not the short run. As firms leave the market, the market price will rise until it is at the point at which firms earn zero profit. At this point, firms in this industry will have no incentive to leave, and firms not in the industry will have no incentive to enter, so the industry will be in long-run equilibrium.

Suppose that the market for cashmere sweaters is a perfectly competitive market. The following graph shows the daily cost curves of a firm operating in this market. In the short run, at a market price of $80 per sweater, this firm will choose to produce_________ sweaters per day. On the previous graph, use the blue rectangle (circle symbols) to shade the area representing the firm's profit or loss if the market price is $80 and the firm chooses to produce the quantity you already selected. Note: In the following question, you should enter a positive number in the numeric entry field. The area of this rectangle indicates that the firm's profit would be $1,925,000 per day.

55,000 If a perfectly competitive firm produces a positive output, it does so by choosing to produce the quantity at which marginal revenue (MRMR) or the market price (PP) is equal to marginal cost (MCMC). Therefore, if this firm chooses to produce sweaters, it will produce 55,000 sweaters per day, the quantity at which marginal cost is equal to the price of $80 per sweater. It's important to double-check that the firm will, in fact, choose to produce anything at all when the price is $80 per sweater. A firm's decision on whether to produce in the short run depends on whether it can earn enough revenue to cover its variable cost. Because $80 is greater than the lowest point on the average variable cost (AVCAVC) curve, this condition is met. Whether a firm earns a positive profit or takes an economic loss is determined by the relative magnitudes of total revenue and total cost. When total revenue exceeds total cost, the firm earns a positive profit; but when total cost exceeds total revenue, the firm suffers an economic loss (also called a negative profit). Profit is equal to total revenue (TRTR) minus total cost (TCTC). Total revenue, in turn, is equal to price (PP) times quantity (QQ): TRTR = = P×QP×QFurthermore, since average total cost (ATCATC) is equal to total cost divided by quantity produced, you can write total cost in terms of ATCATC and QQ:ATCATC = = TCQTCQTCTC = = ATC×QATC×QSubstituting TR=P×QTR=P×Q and TC=ATC×QTC=ATC×Q into the equation for profit results in the following:ProfitProfit = = TR−TCTR−TC = = (P×Q)−(ATC×Q)P×Q−ATC×Q = = (P−ATC)×QP−ATC×QIn other words, profit may be shown as a rectangle with a base of QQ that stretches vertically to represent the difference of P−ATCP−ATC. When ATCATC is greater than PP, this rectangle represents the firm's economic loss.Substituting P=$80P=$80 per sweater, ATC=$45 per sweater, and Q=55,000 sweaters per day into the equation for profit indicates that the firm's profit would be $1,925,000:ProfitProfit = (P−ATC)×QP−ATC×Q = = ($80 per sweater−$45 per sweater)×55,000 sweaters per day$80 per sweater−$45 per sweater×55,000 sweaters per day = = $35 per sweater×55,000 sweaters per day$35 per sweater×55,000 sweaters per day = = $1,925,000

Suppose that the market for cashmere sweaters is a perfectly competitive market. The following graph shows the daily cost curves of a firm operating in this market. In the short run, at a market price of $80 per sweater, this firm will choose to produce ___________ sweaters per day. On the previous graph, use the blue rectangle (circle symbols) to shade the area representing the firm's profit or loss if the market price is $80 and the firm chooses to produce the quantity you already selected. Note: In the following question, you should enter a positive number in the numeric entry field. The area of this rectangle indicates that the firm's _______ would be ___________per day.

55,000 If a perfectly competitive firm produces a positive output, it does so by choosing to produce the quantity at which marginal revenue (MRMR) or the market price (PP) is equal to marginal cost (MCMC). Therefore, if this firm chooses to produce sweaters, it will produce 55,000 sweaters per day, the quantity at which marginal cost is equal to the price of $80 per sweater. It's important to double-check that the firm will, in fact, choose to produce anything at all when the price is $80 per sweater. A firm's decision on whether to produce in the short run depends on whether it can earn enough revenue to cover its variable cost. Because $80 is greater than the lowest point on the average variable cost (AVCAVC) curve, this condition is met. profit, $1,925,000 Whether a firm earns a positive profit or takes an economic loss is determined by the relative magnitudes of total revenue and total cost. When total revenue exceeds total cost, the firm earns a positive profit; but when total cost exceeds total revenue, the firm suffers an economic loss (also called a negative profit). Profit is equal to total revenue (TRTR) minus total cost (TCTC). Total revenue, in turn, is equal to price (PP) times quantity (QQ): TR = P×Q Furthermore, since average total cost (ATCATC) is equal to total cost divided by quantity produced, you can write total cost in terms of ATCATC and Q: ATC = TC / Q TC= ATC×Q Substituting TR=P×QTR=P×Q and TC=ATC×QTC=ATC×Q into the equation for profit results in the following: Profit= TR−TC = (P×Q)−(ATC×Q) = (P−ATC)×Q In other words, profit may be shown as a rectangle with a base of QQ that stretches vertically to represent the difference of P−ATCP−ATC. When ATCATC is greater than PP, this rectangle represents the firm's economic loss. Substituting P=$80P=$80 per sweater, ATC=$45ATC=$45 per sweater, and Q=55,000Q=55,000 sweaters per day into the equation for profit indicates that the firm's profit would be $1,925,000: Profit = (P−ATC)×Q = ($80 per sweater−$45 per sweater)×55,000 sweaters per day = $35 per sweater×55,000 sweaters per day = $1,925,000

Talero is one of more than a hundred competitive firms in San Diego that produce extra-large cardboard boxes for moving. The following graph shows the daily market demand and supply curves. On the following graph, use the green line (triangle symbol) to plot the demand curve for Talero's extra-large cardboard boxes. Fill in the price and the total, marginal, and average revenue Talero earns when it produces 0, 1, 2, or 3 boxes each day. Quantity Price Total Marginal Average Revenue Revenue Revenue (Boxes) ($ per box) ($) ($) ($ per box) 0 25 0 - 1 25 25 25 25 2 25 50 25 25 3 25 75 25 25 The demand curve that Talero faces is identical to which of its other curves? Check all that apply. - Supply curve - Average revenue curve - Marginal cost curve - Marginal revenue curve

Equilibrium is at (5,25) Horizontal line at y=25 In a competitive market, many firms sell an identical product to many buyers. Therefore, if Talero charges even slightly more for a box than other firms charge, it will lose all its customers because every other firm in the industry is offering a lower price. In other words, one of Talero's boxes is a perfect substitute for boxes from the factory next door or from any other factory. On the other hand, if Talero charges less than what other firms charge, Talero would also be worse off because the quantity sold would remain the same since the firm can already sell as much output as it wants at the market price; but the revenue from each unit sold would be lower. Thus, a competitive firm faces a perfectly elastic (horizontal) demand curve for its output at the current market price (in this case, $25 per extra-large box). It is important to note that while the demand curve of a competitive firm is perfectly elastic, the market demand curve of a competitive market (as shown on the first graph), still obeys the law of demand and is downward sloping. All are correct Since a competitive firm faces a perfectly elastic demand curve at the market price, it can sell any quantity it chooses at this price. This is shown as a horizontal demand curve at the market price. Because all units produced are sold at the market price, the change in total revenue that results from a one-unit increase in the quantity sold is equal to the price. Thus, the marginal revenue curve is a horizontal line at the market price. Therefore, the demand curve and the marginal revenue curve are the same. Because all units produced are sold at the market price, the average amount of revenue per unit sold is also equal to the market price. Therefore, the demand curve and the average revenue curve are the same. A firm's demand curve has nothing to do with the firm's cost structure because demand is constructed from buyers' preferences about the good or service being sold, but cost depends on things such as input prices and methods of production.

Suppose that the perfectly competitive tuna industry is in long-run equilibrium at a price of $3 per can of tuna and a quantity of 600 million cans per year. Suppose the Surgeon General issues a report saying that eating tuna is bad for your health. The Surgeon General's report will cause consumers to demand less tuna at every price. In the short run, firms will respond by producing less tuna and running at a loss . Shift the supply curve, the demand curve, or both on the following diagram to illustrate these short-run effects of the Surgeon General's announcement. Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther. In the long run, some firms will respond by exiting the industry until each firm in the industry is once again earning zero profit Shift the supply curve, the demand curve, or both on the following diagram to illustrate both the short-run effects of the Surgeon General's announcement and the new long-run equilibrium after firms and consumers finish adjusting to the Surgeon General's announcement.

Filled out to the left Shift the demand curve down one The Surgeon General's report causes demand for tuna to decrease. In the short run, the number of firms in the tuna industry is fixed. Therefore, the shift in demand causes a movement along the short-run supply curve. The price of tuna decreases, and each firm produces less tuna than before. Because the tuna industry was originally in long-run equilibrium, firms were earning zero profit before the Surgeon General's announcement. Therefore, a decrease in price would cause firms to be running at a loss. Filled out to the left Shift the Supply line up one and demand line down one The Surgeon General's report causes the demand for tuna to decrease. Nothing happens in the long run to change that; therefore, you should once again have shifted the demand curve to the left. The Surgeon General's report also caused the price of tuna to decrease, which meant firms in this industry were running at a loss. In the short run, the number of firms in the tuna industry is fixed; in the long run, firms in the tuna industry that run a negative profit will exit the market. As they do, the supply curve shifts to the left, raising the short-run equilibrium price. This process continues until firms once again earn zero economic profits. Note that the long-run equilibrium price at the new (lower) equilibrium quantity is the same as the equilibrium price at the original quantity, indicating that the long-run average total cost curve is horizontal. Because average total cost remains constant as industry output falls, the equilibrium price is the same at lower industry output levels. Industries with horizontal long-run average total cost curves are known as constant-cost industries.

Suppose that the perfectly competitive shrimp industry is in long-run equilibrium at a price of $3 per pound of shrimp and a quantity of 600 million pounds per year. Suppose the Surgeon General issues a report saying that eating shrimp is good for your health. The Surgeon General's report will cause consumers to demand more shrimp at every price. In the short run, firms will respond by producing more shrimp and earning positive profit . Shift the supply curve, the demand curve, or both on the following diagram to illustrate these short-run effects of the Surgeon General's announcement. Note: Select and drag one or both of the curves to the desired position. Curves will snap into position, so if you try to move a curve and it snaps back to its original position, just drag it a little farther. In the long run, some firms will respond by entering the industry until each firm in the industry is once again earning zero profit Shift the supply curve, the demand curve, or both on the following diagram to illustrate both the short-run effects of the Surgeon General's announcement and the new long-run equilibrium after firms and consumers finish adjusting to the Surgeon General's announcement.

Filled out to the left Shift the demand line up one The Surgeon General's report causes demand for shrimp to increase. In the short run, the number of firms in the shrimp industry is fixed. Therefore, the shift in demand causes a movement along the short-run supply curve. The price of shrimp increases, and each firm produces more shrimp than before. Because the shrimp industry was originally in long-run equilibrium, firms were earning zero profit before the Surgeon General's announcement. Therefore, an increase in price would cause firms to be earning positive profit. Filled out to the left Shift the supply line down one and demand line up one The Surgeon General's report causes the demand for shrimp to increase. Nothing happens in the long run to change that; therefore, you should once again have shifted the demand curve to the right. The Surgeon General's report also caused the price of shrimp to increase, which meant firms in this industry were earning positive profit. In the short run, the number of firms in the shrimp industry is fixed; in the long run, firms in other industries will enter the shrimp industry to get a share of the profit. As they do, the supply curve shifts to the right, lowering the short-run equilibrium price. This process continues until firms once again earn zero economic profits. Note that the long-run equilibrium price at the new (higher) equilibrium quantity is lower than the equilibrium price at the original quantity, indicating that the long-run average total cost curve is downward-sloping. Because average total cost falls as industry output rises, the equilibrium price is lower at higher industry output levels. Industries with downward-sloping long-run average total cost curves are known as decreasing-cost industries.

Falero is one of more than a hundred competitive firms in Denver that produce small cardboard boxes for moving. The following graph shows the daily market demand and supply curves. On the following graph, use the green line (triangle symbol) to plot the demand curve for Falero's small cardboard boxes. Fill in the price and the total, marginal, and average revenue Falero earns when it produces 0, 1, 2, or 3 boxes each day. Quantity Price Total Marginal Average Revenue Revenue Revenue (Boxes) ($ per box) (Dollars) (Dollars) ($ per box) 0 5 0 - 1 5 5 5 5 2 5 10 5 5 3 5 15 5 5 The demand curve that Falero faces is identical to which of its other curves? Check all that apply. - Marginal cost curve - Average revenue curve - Marginal revenue curve - Supply curve

Green line goes straight across at y=5 In a competitive market, many firms sell an identical product to many buyers. Therefore, if Falero charges even slightly more for a box than other firms charge, it will lose all its customers because every other firm in the industry is offering a lower price. In other words, one of Falero's boxes is a perfect substitute for boxes from the factory next door or from any other factory. On the other hand, if Falero charges less than what other firms charge, Falero would also be worse off because the quantity sold would remain the same since the firm can already sell as much output as it wants at the market price; but the revenue from each unit sold would be lower. Thus, a competitive firm faces a perfectly elastic (horizontal) demand curve for its output at the current market price (in this case, $5 per small box). It is important to note that while the demand curve of a competitive firm is perfectly elastic, the market demand curve of a competitive market (as shown on the first graph), still obeys the law of demand and is downward sloping. Because the market is competitive, Falero is a price taker. Thus, no matter how many boxes it sells, it receives $5 for each one. You can calculate Falero's total revenue by multiplying price and quantity: Total Revenue = Price×Quantity = $5 per box×1 box = $5 Each small box that Falero sells earns the company $5 in revenue. Therefore, the marginal revenue from each small box sold is $5. Average revenue is equal to total revenue divided by quantity: Average Revenue = Total Revenue / Quantity = (Price×Quantity) / Quantity = price All are correct Since a competitive firm faces a perfectly elastic demand curve at the market price, it can sell any quantity it chooses at this price. This is shown as a horizontal demand curve at the market price. Because all units produced are sold at the market price, the change in total revenue that results from a one-unit increase in the quantity sold is equal to the price. Thus, the marginal revenue curve is a horizontal line at the market price. Therefore, the demand curve and the marginal revenue curve are the same. Because all units produced are sold at the market price, the average amount of revenue per unit sold is also equal to the market price. Therefore, the demand curve and the average revenue curve are the same. A firm's demand curve has nothing to do with the firm's cost structure because demand is constructed from buyers' preferences about the good or service being sold, but cost depends on things such as input prices and methods of production.

The model of competitive markets relies on the following four core assumptions: 1. There must be many buyers and sellers, none of which is large in relation to total sales or purchases. In other words, a few players can't dominate the entire market.2. Each firm produces and sells a homogeneous product that is indistinguishable from all other firms' products in a given industry. That is, buyers must regard all sellers' products as equivalent, or identical.3. Buyers and sellers have all relevant information about prices, product quality, sources of supply, etc. 4. Firms have free entry into and exit from the industry. New firms can enter the market easily, and existing firms can exit the market easily. There are no barriers to entry or exit. The first three assumptions imply that all consumers and firms are price takers. The final assumption is not necessary for price-taking behavior, but guarantees that a market remains competitive in the long run. Identify whether or not each of the following scenarios describes a perfectly competitive market, along with the correct explanation of why or why not. In a small town, there are two providers of broadband Internet access: a cable company and a phone company. The Internet access offered by both providers is of the same speed. In a major metropolitan area, one chain of coffee shops has gained a large market share because customers feel its coffee tastes better than that of its competitors Dozens of companies produce plain white socks. Consumers regard plain white socks as standardized and don't care who manufactures their socks. The government has granted a patent to a pharmaceutical company for an experimental AIDS drug. That company is the only firm permitted to sell the drug.

In a small town, there are two providers of broadband Internet access: a cable company and a phone company. The Internet access offered by both providers is of the same speed. ----No, Not many sellers In a major metropolitan area, one chain of coffee shops has gained a large market share because customers feel its coffee tastes better than that of its competitors------ No, not a standardized product Dozens of companies produce plain white socks. Consumers regard plain white socks as standardized and don't care who manufactures their socks.-----Yes, meets all assumptions The government has granted a patent to a pharmaceutical company for an experimental AIDS drug. That company is the only firm permitted to sell the drug.------ No, no fee entry The sock market is the only one of these options that is a perfectly competitive market. Because the pharmaceutical company is the only legal provider of the experimental AIDS drug, there isn't free entry into that market. Since there is only one seller and the good is unique, the answers No, not many sellers and No, not a standardized product would also be accepted. Because a few firms dominate the broadband Internet market, they are not price takers. Finally, consumers regard the products offered by various coffee shops as different, so the coffee market is not characterized by a standardized product.

Suppose Beth runs a small business that manufactures shirts. Assume that the market for shirts is a competitive market, and the market price is $20 per shirt. The following graph shows Beth's total cost curve. Use the blue points (circle symbol) to plot total revenue and the green points (triangle symbol) to plot profit for the first seven shirts that Beth produces, including zero shirts. Calculate Beth's marginal revenue and marginal cost for the first seven shirts she produces, and plot them on the following graph. Use the blue points (circle symbol) to plot marginal revenue and the orange points (square symbol) to plot marginal cost. Beth's profit is maximized when she produces 5 shirts. When she does this, the marginal cost of the last shirt she produces is $15, which is less than the price Beth receives for each shirt she sells. The marginal cost of producing an additional shirt (that is, one more shirt than would maximize her profit) is $25, which is greater than the price Beth receives for each shirt she sells. Therefore, Beth's profit-maximizing quantity corresponds to the intersection of themarginal cost and marginal revenue curves. Because Beth is a price taker, this last condition can also be written as P=MC

Total revenue is equal to price times quantity. Therefore, the total revenue curve is an increasing line with a slope of $20 per unit. Profit is equal to total revenue minus total cost. The following table captures the data needed to plot the total revenue curve and profit curve: Quantity Total Revenue Total Cost Profit (Shirts) (Dollars) (Dollars) (Dollars) 0020-20 12035-15 240400 3604515 4805525 51007030 61209525 714012515 Marginal revenue is equal to the additional revenue earned for each additional shirt sold. For a competitive firm, marginal revenue is always equal to the market price. Since Beth can sell as many shirts as she can make at a price of $20 per shirt, her marginal revenue from selling any given shirt is $20. Marginal cost is the change in cost when Beth increases production by one shirt. You can find this by calculating the difference between each total cost given in the following table. For instance, the marginal cost of the fourth shirt ($10) is equal to the total cost of producing four shirts ($55) minus the total cost of producing three shirts ($45): Quantity Total Revenue Marginal Revenue Total Cost Marginal Cost (Shirts)(Dollars)(Dollars)(Dollars)(Dollars) 00 20 20151203520524040205360452010480552015510070202561209520307140125 As shown on the first graph, profit is maximized at an output level of 5 shirts. At this quantity, the difference between total revenue and total cost is greatest. Another way of thinking about this is to realize that for the first 5 shirts that Beth produces, the marginal cost (MC) of producing each shirt is less than the marginal revenue (MR) she receives from selling the shirt. Beyond the fifth shirt she produces each hour, the marginal cost of producing that shirt is greater than the price Beth receives for it; therefore, choosing to produce more than 5 shirts reduces Beth's profit. Because MR>MCMR>MC ($20>$15$20>$15) to the left of the optimal quantity and MR<MCMR<MC ($20<$25$20<$25) to the right of the optimal quantity, the optimal quantity corresponds to the intersection of the marginal cost and marginal revenue curves. (Note: When the two curves intersect between discrete values, the optimal quantity occurs at the greatest quantity where marginal cost is below marginal revenue.) Furthermore, since marginal revenue is always equal to price (P) for a firm in a competitive market, the optimal quantity for such a firm is the one at which P=MCP=MC.