Chapter 12 - Perfect Competition

UNIVERSITY OF TORONTO DEPARTMENT OF ECONOMICS

ECO100: INTRODUCTORY ECONOMICS R OBERT OBERT G AZZALE, PHD PRACTICE PROBLEMS PERFECT COMPETITION

1. (Table: Variable Costs for Lots) Look at the table Variable Costs for Lots. During the winter, Alexa runs a snow-clearing service, and snow clearing is a perfectly competitive industry. The table provided shows her variable costs for snow clearing and number of lots cleared. Her only fixed cost is $1,000 $1,000 for a snowplow. Her variable costs include fuel, her time, and hot coffee. If the price per cleared lot is $14, how many lots should Alexa clear? A) 0 B) 40 C) 50 D) 20 2. Perfectly competitive firms will: A) maximize total revenue by using the marginal decision rule. B) increase output up to the point that the marginal benefit of an additional unit of output is greater than the marginal cost. C) increase output up to the point that the marginal benefit of an additional unit of output is equal to the marginal cost. D) always attempt to minimize average variable cost. 3. In perfect competition, a change in fixed cost: A) will cause a change in the price in the short run. B) will cause a change in output in the short run. C) will encourage entry or exit in the long run so that price will change enough to leave firms earning zero profits. D) will cause a change in variable cost, too. 4. Bob runs a pedicure business in a perfectly competitive industry. He knows that he will break even if the price of pedicures is $15 but that he will have to shut down if the price is $11. If the market demand in Q, then in the short run, Bob will: the industry is P = = 30 – (0.2) Q and the market supply is P = = (0.2) Q, A) shut down, since he cannot cover any of his variable costs. B) produce, since he is at his break-even level. C) produce with a loss, since he is operating at a price below his break-even level. D) shut down, although he is making a positive economic profit. 5. (Table: Total Cost and Output: See question 37) The table describes Sergei's total costs for his perfectly competitive all-natural ice cream firm. If the market price of a tub of ice cream is $67.50, $67.50, how much is Sergei's total cost at the profit-maximizing output? A) $270 201211

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P RACTICE PROBLEMS: PERFECT COMPETITION


ECO100: INTRODUCTORY ECONOMICS R OBERT G AZZALE, PHD

B) $170 C) $135 D) $67.50 6. Suppose that the market for candy canes operates under conditions of perfect competition, that it is initially in long-run equilibrium, and that the price of each candy cane is $0.10. Now suppose that the price of sugar rises, increasing the marginal and average total cost of producing candy canes by $0.05; there are no other changes in production costs. Based on the information given, we can conclude that once all of the adjustments to long-run equilibrium have been made, the price of candy canes will equal: A) $0.05. B) $0.10. C) $0.15. D) The question is impossible to answer without knowing exactly how many firms entered and/or left the industry.

7. (Figure: A Perfectly Competitive Firm in the Short Run) Look at the figure A Perfectly Competitive Firm in the Short Run. The firm's total revenue from the sale of its most profitable level of output is: A) 0GLD. B) 0GHB. C) BH. D) DL. 8. (Figure: A Perfectly Competitive Firm in the Short Run) Look at the figure A Perfectly Competitive Firm in the Short Run. The firm's total economic profit at its most profitable level of output is: A) 0GHB. B) EFJS. C) EGHS. D) FGLK. 9. (Figure: A Perfectly Competitive Firm in the Short Run) Look at the figure A Perfectly Competitive Firm in the Short Run. If the market price is G, the firm's total cost of producing its most profitable level of output is: A) BS. B) DK. 201211

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C) 0FKD. D) 0 ESB. 10. (Figure: A Perfectly Competitive Firm in the Short Run) Look at the figure A Perfectly Competitive Firm in the Short Run. The firm's total cost of producing its most profitable level of output is: A) BS. B) DK. C) 0FKD. D) 0 ESB. 11. (Figure: A Perfectly Competitive Firm in the Short Run) Look at the figure A Perfectly Competitive Firm in the Short Run. If market price is G, the firm's total revenue from the sale of its most profitable level of output is: A) 0GLD. B) 0GHB. C) BH. D) DL. 12. (Figure: A Perfectly Competitive Firm in the Short Run) Look at the figure A Perfectly Competitive Firm in the Short Run. If market price is G, the firm's total economic profit at its most profitable level of output is: A) 0GHB. B) EFJS. C) EGHS. D) FGLK. 13. When economic profits in an industry are zero: A) firms are really doing badly. B) firms are doing as well as they could do in other markets. C) firms should exit so they can make an economic profit in some other market. D) the industry is not in long-run equilibrium. 14. For the Colorado beef industry to be classified as perfectly competitive, ranchers in Colorado must have ________ on prices and beef must be a ________ product. A) no noticeable effect; standardized B) a huge effect; standardized C) a huge effect; differentiated D) no noticeable effect; differentiated 15. Wenqin is a farmer, and in the short run she produces 100 bushels of wheat. Her average total cost per bushel is $1.75, total revenue is $450, and (total) fixed costs are equal to $100. Wenqin's: A) average fixed cost is equal to $1.50. B) profit per bushel is equal to $2.75. C) average variable cost is equal to $1.25. D) economic profit is equal to $250.

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Figure: The Perfectly Competitive Firm

16. (Figure: The Perfectly Competitive Firm) Look at the figure The Perfectly Competitive Firm. The firm faces demand curve d, has the cost curves shown, and maximizes profit. In a long-run equilibrium, this firm will produce ________ units of output and sell its output at a price of ________. A) 100; $1.00 B) 250; $1.90 C) 300; $2.00 D) 400; $3.00 17. (Figure: The Perfectly Competitive Firm) Look at the figure The Perfectly Competitive Firm. The figure shows a perfectly competitive firm that faces demand curve d, has the cost curves shown, and maximizes profit. The firm's economic profit in the long run will be: A) $0. B) $250. C) $275. D) $300. 18. Zoe's Bakery operates in a perfectly competitive industry. When the market price of iced cupcakes is $5, the profit-maximizing output level is 150 cupcakes. Her average total cost is $4, and her average variable cost is $3. Zoe's marginal cost is ________, and her shor t-run profits are: A) $5; $150 B) $5; $300 C) $1; $150 D) $1; $300 19. Zoe's Bakery operates in a perfectly competitive industry. The variable costs at Zoe's Bakery increase, so all of the cost curves (with the exception of fixed cost) shift leftward. The demand for Zoe's pastries does not change, nor does the firm shut down. To maximize profits after the variable cost increase, Zoe's Bakery will ________ its price and ________ its level of production. A) raise; increase B) decrease; increase C) raise; decrease D) do nothing to; decrease

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20. (Table: Soybean Cost) Look at the table Soybean Cost. The costs of production of a perfectly competitive soybean farmer are given in the table. What is the break-even price for this farmer? A) $13.00 B) $13.50 C) $14.00 D) $14.50 21. (Table: Soybean Cost) Look at the table Soybean Cost. The costs of production of a perfectly competitive soybean farmer are given in the table. What is the shut-down price for this firm? A) $10 B) $11 C) $12 D) $13 22. Cindy's Nails operates in the perfectly competitive pedicure industry. The city is considering requiring nail salons to be certified by a health inspector. The certification will cost $1,000 annually and is thus a fixed cost. The certification will affect Cindy's decision to operate, not the number of pedicures she chooses to perform if she operates. A) True B) False 23. A perfectly competitive firm will continue producing in the short run as long as it can cover its: A) total cost. B) average fixed cost. C) variable cost. D) fixed cost. 24. Which of the following is true? A) If the price falls below the average total cost, the firm will shut down in the short run. B) Price and marginal revenue are the same in perfect competition. C) Economic profit per unit is found by subtracting AVC from the price. D) Economic profit is always positive in the short run. 25. Which of the following is not an assumption of the model of perfect competition? A) Firms seek to maximize profits. B) The products of each firm in a particular market are identical. C) Each firm sets its price equal to its average total cost. D) There is easy entry and exit. 201211

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26. (Table: Total Cost and Output) The table describes Sergei's total costs for his perfectly competitive allnatural ice cream firm. If the market price of a tub of ice cream is $67.50, how much is Sergei's total revenue at the profit-maximizing output? A) $270 B) $170 C) $135 D) $67.50

27. (Table: Lilly's Apple Orchard) Look at the table Lilly's Apple Orchard. Lilly is the price-taking owner of an apple orchard; the orchard's variable costs are given in the table. Her orchard has fixed costs of $30. If the price of a bushel of apples is $85, we would expect: A) total industry output to rise and Lilly's output to rise in the lo ng run. B) total industry output to fall and Lilly's output to fall in the long run. C) total industry output to fall and Lilly's output to rise in the long run. D) total industry output to rise and Lilly's output to fall in the long run. Figure: The Profit Maximizing Firm

28. (Figure: The Profit Maximizing Firm) Look at the figure The Profit Maximizing Firm. The figure shows cost curves for a firm operating in a perfectly competitive market. Which of the following statements is true? A) AFC is represented in this figure by the vertical distance between curve M and curve N at any level of output. B) AFC is represented in this figure by the vertical distance between curve N and curve O at any level of 201211

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output. C) This figure illustrates the long run because all costs are variable. D) Quantity q 2 is to the left of the shut-down point. Figure: Prices, Cost Curves, and Profits

29. (Figure: Prices, Cost Curves, and Profits) Look at the figure Prices, Cost Curves, and Profits. If the price is P 1 and the firm decides to produce at output Q1, then the firm earns: A) a loss equal to ( ba ) Q1. B) a loss equal to ( ca ) Q1. C) a loss equal to ( bc ) Q1. D) zero. !

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30. (Figure: Prices, Cost Curves, and Profits) Look at the figure Prices, Cost Curves, and Profits. If the price is P 2 and the firm is profit maximizing, then the firm's profit is: A) ( fg ) Q3. B) ( de ) Q2. C) ( fg ) Q2. D) ( de ) P 2. !

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31. A firm produces at the output level at which its average total costs are minimized. At this output level, its average total costs are equal to all of the following except: A) price. B) MC. C) MR. D) AVC. 32. The shut-down point in the short run is: A) the point at which economic profit is zero. B) the minimum point of AVC. C) the intersection of the MC and ATC curves. D) the minimum point of AFC. 33. Suppose that the market for candy canes operates under conditions of perfect competition, that it is initially in long-run equilibrium, and that the price of each candy cane is $0.10. Now suppose that the price of sugar rises, increasing the marginal and average total costs of producing candy canes by $0.05. Based on the information given, we can conclude that in the short run a typical producer of candy canes will be making: A) an economic profit. 201211

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B) zero economic profit. C) negative economic profits. D) The answer is impossible to determine based on the information given. Figure: The Perfectly Competitive Firm II

34. (Figure: The Perfectly Competitive Firm II) Look at the figure The Perfectly Competitive Firm II. If this firm's MR curve is MR 1, the firm will maximize profit by producing ________ units of output and its economic profit will be ________. A) Q1; positive B) Q2; negative C) Q3; positive D) Q4; negative 35. (Figure: The Perfectly Competitive Firm II) Look at the figure The Perfectly Competitive Firm II. If this firm's MR curve is MR 2, then this firm will maximize profit by producing ________ units of output and its economic profit will be ________. A) Q1; positive B) Q2; negative C) Q3; positive D) Q4; negative 36. If all firms in an industry are price-takers, then: A) each firm can sell at the price it wants to charge, provided it is not too different from the prices other firms are charging. B) each firm takes the market price as given for its current output level, recognizing that the price will change if it alters its output significantly. C) an individual firm cannot alter the market price even if it doubles its output. D) the market sets the price, and each firm can take it or leave it (by setting a different price).

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37. (Table: Total Cost and Output) Look at the table Total Cost and Output. The table describes Sergei's costs for his perfectly competitive all-natural ice cream firm. If the market price of a tub of ice cream is $67.50, how many tubs of ice cream will Sergei's firm produce? A) 1 B) 2 C) 3 D) 4

38. (Table: Short-Run Supply Curve) Look at the table Short-Run Supply Curve. The table lists three supply points for an individual, perfectly competitive firm operating in the short run. If the industry is composed of 120 identical firms, which of the following will be a point on the short-run industry supply curve? A) Price = $5; quantity = 1,650. B) Price = $1,200; quantity = 40. C) Price = $960; quantity = 3,840. D) Price = $10; quantity = 4,800. 39. Suppose a perfectly competitive firm can increase its profits by increasing its output. Then it must be true that the firm's: A) marginal revenue exceeds its marginal cost. B) price exceeds its average variable cost but is less than average total cost. C) marginal cost exceeds its marginal revenue. D) price exceeds its marginal revenue. 40. The equilibrium price of a guidebook is $35 in the perfectly competitive guidebook industry. Our firm produces 10,000 guidebooks for an average total cost of $38, marginal cost of $30, and average variable cost of $30. Our firm should: A) raise the price of guidebooks, because the firm is losing money. B) keep output the same, because the firm is producing at minimum average variable cost. C) produce more guidebooks, because the next guidebook produced increases profit by $5. D) shut down, because the firm is losing money. 41. The market for beef is in long-run equilibrium at a price of $3.25 per pound. The announcement that mad cow disease has been discovered in the United States reduces the demand for beef sharply, and the price falls to $2.00 per pound. If the long-run supply curve is horizontal, then when the long-run equilibrium is reestablished, the price will be: A) $3.25 per pound. B) $2.00 per pound. C) greater than $2.00 per pound but less than $3.25 per pound. D) More information is needed to answer this question.

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42. Consider a perfectly competitive firm in the short run. Assume that it is sustaining economic losses but continues to produce. At the profit-maximizing (loss-minimizing) output, all of the following statements are correct except : A) marginal cost is less than average total cost. B) marginal cost is equal to marginal revenue. C) price is equal to marginal cost. D) marginal cost is less than average variable cost. 43. State and explain the price-taking firm's optimal output rule. 44. If it produces, a perfectly competitive firm will maximize profits when the: A) marginal revenue equals marginal cost. B) marginal revenue is lower than average variable cost. C) price is lower than marginal cost. D) price is higher than marginal cost.

45. (Table: Lilly's Apple Orchard) Look at the table Lilly's Apple Orchard. Lilly is the price-taking owner of an apple orchard; her variable costs are given in the table. Her orchard has fixed costs of $30. If the price of a bushel of apples is $80, how many bushels will Lilly produce? Is this a long-run equilibrium? If not, what will be the price of a bushel of apples in the long run? Show your work. 46. In a perfectly competitive industry, the market demand curve is usually: A) perfectly inelastic. B) perfectly elastic. C) downward sloping. D) relatively elastic.

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Answers 1. A 2. C 3. C 4. B 5. B 6. C 7. A 8. D 9. C 10. C 11. A 12. D 13. B 14. A 15. B 16. B 17. A 18. A 19. D 20. B 21. A 22. True 23. C 24. B 25. C 26. A 27. D 28. B 29. B 30. B 31. D 32. B 33. C 34. C 35. B 36. C 37. D 38. D 39. A 40. C 41. A 42. D 43. The firm needs to produce at the output level where P = MR = MC . For every unit that the firm produces, the firm earns additional revenue equal to the market price: P = MR . And for every unit that the firm produces, the firm incurs additional cost, MC . For all units where P = MR > MC , the firm is adding to total profit and should therefore produce those units. While P = MR is constant for these price-taking firms, the MC increases as the firm produces additional units of output. If the firm produces one more unit and P = MR < MC , the firm is losing money on that unit, and so it should not

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be produced. Therefore, the firm will maximize profit at the point where the additional revenue is exactly offset by the additional cost: P = MR = MC . 44. A 45. Lilly should produce 7 bushels, because MC = 80 for the seventh but MC = 90 for the eighth. Her economic profit is equal to $80 7 – $340 – $30 = $190. Because her economic profit is greater than zero, this is not long-run equilibrium. To find the long-run equilibrium price, we need to find ATC at each level of output. First, add $30 of fixed cost to each number in the column of variable cost to get total cost, then divide by the level of output. The minimum ATC occurs at 3 bushels and $36.67, so this is the long-run break-even price. 46. C !

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Chapter 12 - Perfect Competition

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