Economics

CHAPTER 8 1THE FIRM AND THE INDUSTRY UNDER PERFECT COMPETITION TRUE-FALSE QUESTIONS PERFECT COMPETITION DEFINED

1.

Perfect Perfect competiti competition on is an ideal market market structure structure.. ANSWER T, M, R

2.

Perfectly Perfectly competiti competitive ve markets markets have absolute absolutely ly no drawbacks drawbacks.. ANSWER F, M, R

3.

Perfect Perfect competi competition tion forms forms one one extreme extreme of the the market market structure structure spectrum. spectrum. ANSWER T, E, R

4.

Perfect Perfect competiti competition on is character characterized ized by numerous numerous firms. firms. ANSWER T, E, R

5.

It iiss relative relatively ly easy easy for a firm to enter enter a perfect perfectly ly competi competitive tive market. market. ANSWER T, M, R

6.

Perfectly Perfectly competiti competitive ve market marketss feature feature relatively relatively high barriers barriers to to entry. entry. ANSWER F, E, R

7.

Under the theory of perfect perfect competition, competition, firms and buyers know know the availability and prices associated with all products in the market. ANSWER T, M, R

8.

Under perfect competition, firms are relatively relatively ignorant of the the actions actions of their their competitors. ANSWER F, E, R

9.

In perfect competition there are differences in the products sold by various various firms. ANSWER F, M, R

10.

In the long run, a perfectly competitive competitive industry industry tends tends to develop develop differentiated differentiated products. products. ANSWER F, D, R

11.

Perfectly competitive firms are known for being “price makers.” ANSWER F, E, R

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4 y Chapter 8/The Firm and the Industry I ndustry Under Perfect Competition

12.

The market market for for toothpaste toothpaste is a good example of perfect competition. ANSWER F, E, A

13.

Perfectly competitive competitive markets are not the best at producing producing the goods goods that are desired by consumers. ANSWER F, E, R

14.

Perfectly competitive markets are not the most efficient type. ANSWER F, E, R

THE COMPETITIVE FIRM

15.

A perfectly competitive firm is a “price taker” because it cannot sell sell its product for more than the market price. ANSWER T, E, R

16. A perfectl perfectly y competit competitive ive firm firm is is a “price “price maker.” maker.” ANSWER F, M, R 17.

A perfectly competitive firm may, under some some circumstances, circumstances, be able to affect the market price. ANSWER F, E, R

18.

A perfectly competitive firm has a horizontal horizontal demand demand curve because because it can sell as much as it wants at the market price. ANSWER T, E, R

19.

The demand curve of a perfectly competitive firm is is vertical. vertical. ANSWER F, E, R

20.

In perfect competition, competition, a firm’s firm’s marginal marginal revenue equals the the price of the product. ANSWER T, D, A

21.

A perfectly competitive firm will not operate operate where MC MC = MR MR but at MC = AC. AC. ANSWER F, M, R

22.

A firm firm operating operating at MC = MR must must be making a profit. ANSWER F, E, A

23.

A perfectly competitive firm can maximize profits profits by producing producing the quantity at which MR exceeds MC by the greatest amount. ANSWER F, M, A

24.

In the short run, run, a perfectly competitive firm firm can make make a profit, profit, a loss, loss, or shut shut down. ANSWER T, M, R

Chapter 8/The Firm and the Industry I ndustry Under Perfect Competition

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25.

In the short run, run, a perfectly competitive firm firm can make make a profit, profit, a loss, loss, or go out of business. ANSWER F, M, R

26.

Once a firm’s marginal marginal revenue revenue curve is known, the the output output level can be determined. ANSWER F, M, A

27.

The short-run short-run equilibrium equilibrium output of a competitive competitive firm is found by equating marginal cost cost with price. ANSWER T, M, R

28.

Total profit profit of a competitive firm can be found by multiplying profit per unit times units sold. ANSWER T, E, A

29.

If a firm sells its its output at a price price greater than than AC, it will earn economic economic profit. ANSWER T, E, A

30.

If a firm sells its its output at a price price greater than than AVC, AVC, it will earn economic economic profit. ANSWER F, M, A

31.

In the short run, run, a firm may have accounting accounting losses losses and and remain in operation. operation. ANSWER T, M, A

32.

If TR < TC, TC, a perfectly competitive competitive firm will always always shut shut down. down. ANSWER F, M, A

33.

As long long as TVC < TR, a firm will have a positive level level of output output in the short short run. ANSWER T, E, A

34.

Using only marginal marginal revenue revenue and marginal cost, cost, we can determine determine whether whether a firm is incurring a profit or a loss. ANSWER F, M, A

35.

The lowest lowest price that that a competitive competitive firm firm will accept accept without without closing its doors doors is found found by examining the average variable cost curve. ANSWER T, M, A

36.

It pays the firm to produce produce only if total variable costs exceed exceed total revenue. ANSWER F, D, A

37.

In the short run, run, if price is is below AC, AC, maximizing maximizing profits really means minimizing total losses. ANSWER T, D, A

38.

The short-run short-run supply curve for a perfectly competitive competitive firm is that portion of the MC curve above the AVC curve. ANSWER T, E, R


39.

The short-run short-run supply curve for the the perfectly competitive firm firm is that that part of the marginal cost curve that lies above the average fixed cost curve. ANSWER F, M, A

40.

A perfectly competitive firm’s short-run short-run supply supply is infinite at the the market price. ANSWER F, E, R

THE COMPETITIVE INDUSTRY

41.

In the short-run, only only a limited limited number of new firms firms may enter enter a perfectly perfectly competitive competitive market. ANSWER F, M, R

42.

The short-run short-run market market demand demand schedule in perfect competition is positively positively sloped. sloped. ANSWER F, E, R

43.

The market market demand demand schedule schedule in perfect perfect competition competition is horizontal. horizontal. ANSWER F, E, R

44.

The entry entry of new firms firms into a perfectly competitive market shifts shifts the the demand curve outward. ANSWER F, M, A

45.

Zero economic economic profit means that that the firm’s owners owners receive no no compensation compensation for their investment. ANSWER F, M, R

46.

The opportunity opportunity cost of a given investment is the potential earnings forfeited forfeited by tying tying up money in the investment. ANSWER T, E, A

47.

Economic profit equals equals gross earnings earnings minus the firm’s direct direct costs. costs. ANSWER F, M, R

48.

Zero profit profit in the the economic economic sense means means that that firms are are earning a normal rate rate of return. return. ANSWER T, M, R

49.

A firm that is earning zero zero economic economic profit should go out of business. business. ANSWER F, M, R

50.

In a long-run equilibrium equilibrium in in a perfectly competitive competitive market, market, the average firm earns positive economic profits. ANSWER F, E, R

51.

In a long-run equilibrium equilibrium in a perfectly competitive market, firms are are selling at a price price equal to marginal cost. ANSWER T, E, R


52.

In a long-run equilibrium equilibrium in a perfectly competitive market, firms are are selling at a price price equal to average cost. ANSWER T, E, R

53.

In the long run, a perfectly competitive competitive firm firm maximizes profit so P = MC = AC. ANSWER T, E, R

54.

In the the long run, a perfectly competitive competitive firm firm earns no accounting accounting profits. profits. ANSWER F, E, A

55.

In long-run long-run equilibrium, equilibrium, a firm in perfect competition competition has no no economic economic profit. profit. ANSWER T, M, R

56.

An industry industry supply curve is the the horizontal horizontal summation summation of the supply curves of all of the the individual firms. ANSWER T, E, A

57.

In the the long run, any firm may enter or or leave a perfectly perfectly competitive competitive market. ANSWER T, E, R

58.

The number of firms in a perfectly perfectly competitive competitive industry is not fixed in the long long run. ANSWER T, M, A

59.

For a perfectly competitive competitive firm, firm, the long-run supply curve is the the long-run average cost cost curve. ANSWER T, M, A

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PERFECT COMPETITION AND ECONOMIC EFFICIENCY

60.

In long-run long-run equilibrium equilibrium in perfect competition, competition, every every firm is producing producing at minimum average cost. ANSWER T, E, R

61.

Firms in a perfectly competitive market produce at minimum minimum average cost cost in the short short run and the long run. ANSWER F, M, A

62.

Subsidizing firms that that pollute pollute will reduce pollution pollution in the long long run. ANSWER F, E, R


MULTIPLE-CHOICE QUESTIONS PERFECT COMPETITION DEFINED

63. 63.

A ma mark rket et a. may be an organize organized d exchange. exchange. b. refers to a set of sellers and buyers whose actions affect a commodity’s price. c. is that that area area in which buyers and and sellers sellers compete compete to to effect a product product price. price. M,R d. All of the above above are correct. correct. 64.

To determine determine whether whether a market is perfectly competitive, competitive, economists economists examine the the a. number number of firms in the market. market. b. similarities among the products of the different firms in the market. c. ease of entry and exit by firms firms in the the market market.. E,R d. All of the the above above are correc correct. t. 65.

The strength strength of the competition competition faced by a company company can profoundly affect its a. pric pricin ing. g. b. output decisions. c. input input decisi decisions ons.. M,A d. All of the above above are correct. correct. 66.

Which of the following is not a characteristic characteristic of of perfect competition? competition? a. Firms and and consumers consumers all have have perfect information information about about the good and market. market. b. Sellers can enter the market easily. c. All goods goods sold are identical identical.. E,R d. All consumers consumers have identical identical individu individual al demand demand curves. curves. 67. A perfect perfectly ly compet competitive itive firm is a price a. giver. E,R b. taker. c. maker. d. lead leader er.. 68.

Which of the following is a characteristic of a perfectly competitive competitive market? market? a. a few large large firms firms b. firms producing specialized products in order to attract consumers c. each individual firm having some control over the market price E,R d. a large large number number of small small firms firms 69. One of the following following is not not a characteristic characteristic of perfect competition. competition. Which is is it? M,R a. Firms Firms advert advertise ise to increase increase their their market market share. share. b. Profits are low. c. Consumers Consumers pay little little attention attention to brand brand names. names. d. Firms pay no no attention attention to their competitors’ output levels.


70. Firms in perfect competition are often often described as price E,R a. taker akerss. b. makers. c. sett setter ers. s. d. lead leader ers. s. 71. Which of the the following following most most resembles resembles a perfectly competitive competitive market? M,I M,I a. the the stoc stock k ma mark rket et b. the publishing industry c. the the steel steel indust industry ry d. the the new car market market 72. E,I

Perfect competition is the term used to describe a. an industry in which all businessmen are honest honest and accommodating. accommodating. b. an industry industry in which numerous numerous firms firms produce produce identical identical products products.. c. an industry industry untouched untouched by governmen governmentt regula regulation tion.. d. the kind of indust industry ry any American American would would support. support.

73. Economis Economists ts study study perfect perfect competiti competition on a. because because many markets markets are perfectly perfectly competiti competitive. ve. b. for its descriptive realism. M,R c. to establish a benchmark by which which to to measure measure the performance of the the economy. d. All of the above above are correct. correct. 74.

Which of of the following following is closest to to the economist’s definition of perfect competition? competition? a. the the airlin airlinee indust industry ry b. the soft drink industry E,I E,I c. the the fish fishin ing g indu indust stry ry d. the long-dist long-distance ance telephon telephonee service service

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75.

The result that perfectly perfectly competitive competitive firms produce produce at the the lowest per-unit cost cost is derived derived from the assumptions of a. homogeneo homogeneous us products. products. b. few sellers. c. firms facing facing horizont horizontal al demand demand curves. curves. D,I D,I d. free free entr entry y and and exit exit.. THE COMPETITIVE FIRM

76.

In a market with perfectly competitive competitive firms, firms, the market demand demand curve is usually usually ______ and the demand curve facing each individual firm ______. a. upward upward sloping; sloping; horizont horizontal al M,R b. downward downward sloping; sloping; horizont horizontal al c. horizont horizontal; al; downward downward sloping sloping d. downward downward sloping; sloping; downward downward sloping sloping 77. A firm firm facing facing a horizo horizontal ntal demand demand curve curve a. cannot cannot affect affect the price it receiv receives es for for its its output. output. b. always produces at an output at which P = MR. c. faces perfectly perfectly elastic elastic demand demand for for its product. product. E,I d. All of the the above above are correc correct. t. 78.

For a perfectly competitive competitive firm, firm, marginal revenue equals equals average revenue because because the a. firm’s firm’s supply supply curve is horizont horizontal. al. b. industry’s demand curve is horizontal D,A c. firm’s firm’s demand demand curve is horizont horizontal. al. d. industry’ industry’ss supply supply curve is horizont horizontal. al. 79.

In a perfectly competitive competitive industry, influence over price price is exerted by a. indiv individu idual al seller sellers. s. b. individual buyers. c. the the larges largestt firms. firms. M,R d. the forces of supply supply and demand. demand. 80. The competitive firm has no influence over price because M,A a. its output is so insignificant relative to to the the market as a whole. b. anti-trust laws constrain perfectly competitive firms. c. consumers consumers establis establish h the prices prices of products. products. d. it doesn’t doesn’t know its demand demand curve. curve.

Chapter 8/The Firm and the Industry Under Perfect Competition

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81. At a perfectly competitive firm’s short-run equilibrium level of of output, output, M,R M,R a. P = MR = MC. MC. b. P = MR, but MR does not equal MC. c. P = MC, but MR does not equal equal MC. MC. d. MR = MC and and P < MR. MR. 82. In short-run equilibrium, a perfectly competitive firm E,R a. may earn earn a profit profit or a loss. loss. b. always earns a profit. c. never never earns earns a profit profit.. d. earns earns a profit profit only if the the firm firm has no fixed fixed cost. cost. 83.

A firm firm in short-run equilibrium always earns positive positive profits if a. SRAC SRAC > P > SRAVC SRAVC.. M,I M,I b. SRAR SRAR > SRAC SRAC.. c. MR = MC. d. SRAC SRAC > MC. MC. FIGURE 8-1

84.

If the profit-maximizing profit-maximizing firm depicted in in Figure 8-1 is perfectly competitive, competitive, how how much output should it produce? a. A b. B E,A c. C d. D

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85.

A firm earns a profit of exactly zero at its optimal optimal output output level only if a. P = MR. b. P = MC. M,A c. P = AC. AC. d. P = SR AVC. AVC.

TABLE 8-1

Q (in units) units ) AFC (in dollars) doll ars) AVC (in dollars) doll ars) 0 C C 2 2.5 18 4 1.25 14 6 0.83 18 8 0.63 30 10 0.5 50 86.

MC (in dollars) doll ars) C 10 14 42 94 170

In Table 8-1 are the the short-run short-run cost schedules schedules of a perfectly competitive firm. firm. If the the market price of output is $50, the firm will produce ______ units and earn a profit of ______. D,I a. 6; $187. 187.002 b. 6; $48 c. 8; $154 $154.9 .966 d. 8; $245 $245.0 .044

FIGURE 8-2


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87.

Figure 8-2 shows shows demand demand and short-run cost cost curves for for a perfectly competitive firm. firm. At its its profit-maximizing level of output, the firm’s short-run TC is represented by area M,I a. ADFO. b. BGHC. c. BGIO. d. ADGI DGIO.

88.

Figure 8-2 shows shows demand demand and short-run cost cost curves for for a perfectly competitive firm. firm. At its its profit-maximizing output, the firm’s total ______ is represented by area ______. a. loss loss;; GBHC GBHC b. profit; ADGHC D,I c. loss; ss; ADEC DEC d. prof profit it;; EGH EGH

89.

Figure 8-2 shows shows demand demand and short-run cost cost curves for for a perfectly competitive firm. firm. In the the short run, this firm would a. earn positive positive economic economic profits. profits. M,I b. earn earn econom economic ic losse losses. s. c. go out out of busine business. ss. d. Cannot be determined with the information given. TABLE 8-2

A perfectly competitive producer has the following short-run average cost curve and marginal cost curve: SR AC = 2Q + 3 MC = 4Q + 3 where costs are measured in dollars and Q represents the firm’s output in units. 90.

If the market price price of wangdoodles wangdoodles is $15 each, the the profit-maximizing profit-maximizing producer producer whose whose short-run cost curves are given in Table 9-2 should produce ______ wangdoodles. a. 0 D,I b. 3 c. 6 d. 15

91. The firm whose whose short-run short-run cost curves are given given in Table Table 8-2 has has a long-run long-run fixed cost of M,A a. $0. b. $2. c. $3. d. $4.


92.

In the short run, perfectly competitive firms can a. make make an econom economic ic profit profit.. b. take a loss. c. brea break k even even.. E,R d. All of the the above above are correc correct. t. FIGURE 8-3

93.

In Figure 8-3, the profit maximizing firm will operate at at a level of a. OJ. b. OG. E,A c. c. OI. d. OH.

94.

In Figure 8-3, the the perfectly perfectly competitive competitive firm is is realizing realizing a a. loss loss equal equal to ABCE. ABCE. b. profit equal to ABCE. M,A c. profit profit equal equal to ABDF. ABDF. d. loss loss equal equal to ABDF. ABDF. 95.

In Figure 8-3, the firm’s minimum minimum cost cost per unit occurs at an output output of a. OJ. E,A b. b. OG. c. OI. d. OH.


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96.

In perfect competition, competition, marginal revenue always equals a. total total revenu revenue. e. b. price. E,R E,R c. aver averag agee cost cost.. d. margin marginal al fixed fixed cost. cost.

97.

A perfectly perfectly competitive competitive firm should should continue continue to expand expand output output until until a. total total revenue revenue exceeds exceeds total total costs. costs. b. total revenue exceeds variable costs. E,R c. marginal marginal revenue revenue equals equals marginal marginal costs. costs. d. average average revenu revenuee equals equals variable variable costs. costs. 98.

A competitive competitive firm will always maximize profits by producing producing where where a. per-unit per-unit costs costs are lowest. lowest. b. total costs and total revenue are equal. E,R c. P = MC. d. P = AC.

FIGURE 8-4

99.

Figure 8-4 shows shows the the industry’s supply and demand curves curves in panel panel (1) and and the cost curves of a firm in the industry in panel (2). At S 1, the firm is a. shut shut down down.. b. incurring losses. c. earning earning zero economic economic profits. profits. M,A d. earning earning econo economic mic profit profit greater greater than zero. zero.


100. Figure 8-4 shows the industry’s supply supply and demand curves in panel (1) and the cost curves of a firm in the industry in panel (2). At S 2, the firm is a. shut shut down down.. b. incurring losses. M,A c. earning earning zero economic economic profits. profits. d. earning earning economic economic profit profit greater greater than zero. zero. 101. Figure 8-4 shows the industry’s supply supply and demand curves in panel (1) and the cost curves of a firm in the industry in panel (2). At S 3, the firm is M,A M,A a. shut shut down down.. b. incurring losses. c. earning earning zero economic economic profits. profits. d. earning earning economic economic profit profit greater greater than zero. zero. 102. The perfectly competitive firm’s short-run short-run shutdown rule is to shut down immediately immediately if a. TR < TC. b. TR < SRFC. M,A M,A c. TR < SRVC SRVC.. d. TR < MC > Q. 103. At a firm’s profit-maximizing profit-maximizing level of output, its price is $200 and its short-run average total cost is $225. The firm a. has a profi profitt of of $25 $25 per unit of output. output. b. should shut down if its short-run average fixed cost is less than $25. c. has a loss loss of $100 per unit of output. output. D,I d. should should shut shut down if its short-run short-run average average variabl variablee cost cost exceeds exceeds $25. 104. A firm can stay in business while taking taking a loss in the short run as long as it covers its a. fixe fixed d cost costs. s. M,R b. variab variable le costs. costs. c. fixed and variable variable costs. costs. d. A firm firm can never stay stay in business when it experiences experiences losses. 105. A firm will shut down if a. TR – TC > TFC. TFC. b. TR + TC > TFC. D,A D,A c. TC – TR > TFC. TFC. d. TFC + TVC > TR. TR. 106. A firm will shut down in the short short run if M,A M,A a. P < AVC. AVC. b. P > AVC. c. AVC AVC > AFC. AFC. d. TR > TC.


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107. If a firm shuts down in the short run, run, its losses are equal equal to a. TC – TR. TR. M,A b. TFC. FC. c. TVC. d. MC. 108. Sunk costs are are created in the short run by a. contract contract for labor labor services. services. b. lease agreement on real estate. c. purcha purchasin sing g machi machiner nery. y. M,I d. All of the the above above are correc correct. t. 109. If a firm shuts down, down, its a. sunk costs costs remain remain unchanged unchanged.. b. revenue will fall to zero. c. short-run short-run variable variable costs costs will will fall to zero. M,I d. All of the the above above are correc correct. t. 110. The short-run supply curve of a perfectly competitive competitive firm a. goes through through the the lowest point on on its short-run average total total cost cost curve but not on its its short-run average variable cost curve. b. goes through the lowest point on its short-run average variable cost curve but not on its short-run average total cost curve. M,A c. goes through through the the lowest point on on both both its short-run average variable variable cost and its its shortshortrun average total cost curves. d. goes through through the lowest lowest point point on its short-run short-run average total cost cost curve and may or may not go through the lowest point on its short-run average variable cost curve. 111. In perfect competition, competition, an increase in fixed costs will eventually eventually cause all except a. reduction reduction in industry industry output. output. D,A b. reduction reduction in a firm’s firm’s output. output. c. reduction reduction in the number number of firms. firms. d. decrease decrease in industry industry supply. supply. 112. The short-run supply supply curve of the competitive competitive firm is the firm’s a. MC curv curve. e. b. AVC curve. M,R c. MC curve above the minimum minimum point point on on the the AVC curve. curve. d. MC curve curve above above the the minimu minimum m point point on on the the AFC curve.


113. If the price falls below below minimum SRAVC, SRAVC, the quantity supplied supplied by the firm will be a. the quantity quantity at minimum minimum MC. M,A M,A b. zero zero.. c. the quantity quantity at the the point point where MC inter intersects sects AC. d. the quantity quantity at minimum minimum AC. 114. The quantity which which a firm will supply in the the short run a. can be read from its average average cost cost curve. curve. b. can be read from its average variable cost curve. M,A c. can be read read from from the the firm’s marginal cost curve above above average average variable variable cost. d. is always zero above minimum average variable cost. FIGURE 8-5

115. In Figure 8-5, points points which lie on the the firm’s short-run supply supply curve are a. A, B, C. M,A M,A b. C, D, H. c. F, E, G. d. A, C, H. THE COMPETITIVE INDUSTRY

116. The supply curve for a competitive competitive industry is obtained obtained by a. making making an an empiric empirical al study study of of histor historical ical data. data. b. vertically summing the supply curves of firms in the industry. c. horizontally horizontally summing summing the average cost cost curves of firms firms in the the industry. industry. M,R d. horizontally horizontally summing summing the supply curves of firms firms in the the industry.


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117. The short run for for the industry is defined defined as a period a. too brief for new new firms firms to enter enter the industry. industry. b. too brief for old firms to leave the industry. c. in which which the number number of of firms firms in in the the industry industry is fixed. fixed. E,I d. All of the the above above are correc correct. t. 118. The long run for the the industry is defined as a period of time long enough enough for a. any new firm that that desires desires to enter enter the industry industry.. b. any old firm that desires to leave the industry. c. all aspects aspects of production production to vary, vary, including including the the number of firms firms in the industry. industry. E,I d. All of the the above above are correc correct. t. 119. When a firm leaves a perfectly perfectly competitive industry, industry, D,I a. the individu individual al demand demand curves curves facing facing remainin remaining g firms firms shift shift up up in the long run. b. short-run industry equilibrium is re-established at a new point along the original short-run industry supply curve. c. the short-run short-run industry industry supply supply curve curve shifts shifts to to the the right. right. d. at the the new long-run equilibrium, the remaining remaining firms in the the industry industry will each receive a higher profit. 120. The short-run supply supply curve of the competitive competitive industry is found by summing summing the a. AC curves of the the indiv individua iduall firms firms in in the the industry industry.. b. AVC curves of the individual firms in the industry. M,I c. MC curves above AVC of the individu individual al firms firms in the industry. industry. d. There is no short-run supply curve in a competitive industry.


121. A firm in a perfectly competitive competitive industry a. is unaffected unaffected by the entrance entrance of new firms firms into the industry, industry, since since entering firms affect only the prices they themselves receive. b. always produces more output in the long run than in the short run. M,R c. may choose choose a different input mix in the long long run than in the the short short run. run. d. earns economic economic profit profit in the long long run but not not in the short short run. FIGURE 8-6

122. Figure 8-6 shows supply and demand conditions conditions in a perfectly competitive competitive industry and for a firm in that industry. Assume the industry initially has supply curve S 1 and demand curve D1. If demand shifts to D 2, then in the short run price will E,I a. rise to A. b. rise to some level between A and B. c. rema remain in at B. d. fall fall to C. 123. Figure 8-6 shows supply and demand conditions conditions in a perfectly competitive competitive industry and for a firm in that industry. At a price of $C, the firm would a. earn zero economic economic profit. profit. M,A b. b. earn negative negative economic economic profit. profit. c. have a zero opportun opportunity ity cost of capital. capital. d. have a negati negative ve oppor opportuni tunity ty cost cost of of capital capital..


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124. Given an industry demand demand curve, QD = 20 – 2P, and an industry supply curve, Q S = 2 + P, industry equilibrium price in the short run will be a. $20. b. $10. D,A c. $6. d. $3. 125. Given an industry demand demand curve, QD = 20 – 2P, and an industry supply curve, Q S = 2 + P, industry equilibrium quantity in the short run will be a. 18. b. 12. c. 10. D,A d. 8. 126. We expect the demand demand curve in the perfectly competitive competitive industry to be E,R E,R a. nega negati tive vely ly slop sloped ed.. b. vertical. c. hori horizo zont ntal al.. d. perfec perfectly tly elasti elastic. c. 127. When a firm enters the steel industry, industry, the short-run equilibrium equilibrium price of steel E,A E,A a. alwa always ys fall falls. s. b. falls only if existing firms gang up on the entrant. c. falls only if existi existing ng firms firms are are earnin earning g no economic economic profit. profit. d. falls only if if the new firm is more more efficient efficient than than existing existing firms. 128. Firms entering a competitive competitive industry will will cause the price of the the product to E,A a. fall. b. rise. c. remain remain consta constant. nt. d. become become more more responsi responsive ve to to consu consumer mer demand. demand. 129. Perfectly competitive firms firms ______ earn zero economic profit in long-run long-run equilibrium because ______. a. always; firms in perfectly competitive industries always maximize output and so flood the market until the equilibrium price of output is driven to zero b. sometimes; the demand curve for an individual perfectly competitive firm may or may not cross the company’s long-run average total cost curve at its lowest point M,I c. always; firms enter whenever their economic profit is positive and exit whenever it’s negative, so in long-run equilibrium economic profit must always be zero d. never; no firm would would be willing to to produce produce if it it received zero economic economic profit profit


130. If the opportunity cost of capital capital is below the rate of return to capital in the perfectly competitive beauty salon industry, D,I a. resources resources will flow into the industry. industry. b. beauty salon owners must be earning negative economic profit. c. the beauty salon industry cannot be in long-run equilibrium. d. beauty salon salon owners owners must be earning earning negative marginal revenue at their current current levels of output. 131. The difference between zero profit and zero economic economic profit is that that M,R a. economists include opportunity opportunity cost in zero zero economic economic profit, profit, while while accountants accountants do not not include opportunity cost in zero profit. b. economists do not include opportunity cost in zero economic profit, while accountants do include opportunity cost in zero profit. c. economists include opportunity opportunity cost in zero zero profit, profit, while while accountants accountants do not not include include opportunity cost in zero economic profit. d. economists do not include opportunity opportunity cost in in zero profit, while while accountants accountants do include opportunity cost in zero economic profit. 132. Helga owns Viking, Inc., started with her her $100,000 inheritance. Helga’s Helga’s accountant informs her that her firm earned a profit of $100,000 last year, and that if she chooses to invest the money she can expect a 10% return. If Helga did not run Viking, she would not work. What were Helga’s economic profits last year? a. Zero b. $100,000 c. $90,0 90,0000 D,A D,A d. $95, $95,00 0000 133. Richard Bland quit his job as an accounting accounting professor to start his own restaurant. restaurant. He gave up a salary of $50,000 per year and withdrew $100,000 in bank CDs earning 5 percent to buy a building and equipment. In the restaurant’s first year it had direct expenses of $75,000 and revenues of $150,000. The restaurant’s economic profit was a. $15, $15,00 000. 0. D,A D,A b. $20, $20,00 000. 0. c. $75, $75,00 000. 0. d. not possible to determine from the information information given. 134. A perfectly competitive firm would be willing willing to remain in the industry in the long run at zero economic profit because a. it would would find it too difficult to exit from the industry industry in the long long run. b. accounting profit would be negative. E,A c. revenue is equal to all costs, including the opportunity opportunity cost cost of capital and labor. d. its sunk costs would prevent it from leaving the industry.


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135. Zero economic profits profits for a perfectly competitive competitive firm in the long long run means a. the firm must exit the industry industry.. E,A b. the the firm firm is in equili equilibri brium. um. c. the firm will shut down until until the the market market impro improves. ves. d. average revenue is insufficient to cover long-run long-run average cost. 136. Long-run average cost of the perfectly competitive competitive firm includes the the a. cost of raw materials materials per unit of output. output. b. opportunity opportunity cost of labor per unit of output. c. opportun opportunity ity cost cost of capit capital al per unit of outpu output. t. M,I d. All of the the above above are correc correct. t. 137. Which of the following following statements is not true in a perfectly competitive competitive industry in longrun equilibrium? D,I a. A profi profit-max t-maximiz imizing ing firm may produce produce any any output output level level at which which P < LRAC. LRAC. b. Every firm produces at an output level at which MC = LRAC. c. There There is no entry entry or or exit exit from from the industry. industry. d. No firm earns an economic economic profit. profit. 138. The perfectly competitive widget industry industry is in long-run equilibrium. A profit-maximizing profit-maximizing manufacturer receives total revenue of $55,000. He uses his labor, $15,000 worth of wire, and $15,000 worth of steel to make the widgets. The manufacturer a. is earning earning an economic economic profit profit of $25,00 $25,000. 0. b. must have an opportunity cost of labor of less than $25,000. D,A c. must have an oppor opportuni tunity ty cost cost of of labor labor of of exactly exactly $25,000. $25,000. d. must have have an opportunity cost of labor labor of more than than $25,000. 139. The entry of firms into into a competitive industry industry causes the supply supply curve to a. incre increase ase its slope. slope. b. decrease its slope. E,A c. mo move ve farth farther er towar toward d the right. right. d. move toward toward the left. left. 140. An increase in demand will cause cause an increase in industry output in the long run because M,I a. new firms firms enter enter the the indust industry. ry. b. new firms enter the industry and all firms increase their output. c. all firms firms decreas decreasee their their output output but more new firms enter. enter. d. no firms enter but the existing firms increase their output.


141. The market for a perfectly competitive competitive industry clears at at a price of $3, and the minimum minimum average cost for all firms is $2.50. In the long run, we would expect an increase in a. each each firm’s firm’s output output.. M,A b. the the number number of firms. firms. c. each each firm’s firm’s profit profit.. d. each firm’s firm’s average average cost. cost. 142. The long-run supply supply curve of an industry equals equals the industry’s a. long-run long-run marginal marginal cost curve. curve. b. the horizontal sum of all firms’ supply curves at any point in time. D,R c. longlong-run run averag averagee cost cost curve. curve. d. long-run long-run total total variable variable cost curve. curve. 143. Regardless of quantity in long-run long-run equilibrium, the industry industry price cannot exceed the M,R a. long-run long-run average average cost cost of supply supplying ing that quantity quantity.. b. total variable cost of supplying that quantity. c. long-run long-run total total cost cost of of supplyi supplying ng that that quantity quantity.. d. minimum long-run marginal cost of supplying that quantity. 144. The long-run industry industry supply curve in perfect competition competition is derived derived from the a. short-run industry supply curve curve which shifts as new new firms enter the industry. industry. b. short-run industry supply curve which shifts as old firms exit the industry. c. freedom of firms from sunk sunk costs costs so that new cost cost curves become long-run long-run curves. M,I d. All answers above are important in deriving the long-run industry supply curve. 145. In a perfectly competitive competitive industry, if price exceeds LRAC, we may be sure a. equilibriu equilibrium m has not been reached. reached. b. new firms will continue to enter the industry. c. the long-run industry supply curve will shift to the right. E,I d. All of the the above above are correc correct. t.


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146. The process of adjustment adjustment to a new long-run long-run equilibrium in a perfectly perfectly competitive industry is complete when a. no firms want to enter or exit the industry. industry. b. every firm has adjusted its production process to make the most efficient use of its resources. c. investors in the the industry industry receive the standard standard economy-wide rate of return return on their investments. M,I d. All of the the above above are correc correct. t. FIGURE 8-7

147. In Figure 8-7, the the price at long-run long-run equilibrium is is a. $5. b. $10. M,A c. $20. d. $35. 148. At its long-run long-run equilibrium level of output, output, the demand curve facing facing an individual perfectly competitive firm is tangent to its a. total total economic economic profit profit curve. curve. M,A b. long-run long-run average average cost curve. c. margin marginal al cost cost curve. curve. d. marginal marginal revenue revenue curve. curve.

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149. Firms will continue continue to enter a competitive competitive industry until a. the supply supply curve is vertical. vertical. b. the supply curve is meaningless. M,R c. any excess excess return returnss have have been been competed competed away. away. d. all resources resources are fully employed. employed. 150. A perfectly competitive competitive industry in long-run long-run equilibrium is described described as efficient because firms M,R a. produce produce at at the the low low point point on their their average average cost curve. curve. b. produce where marginal cost yields a profit. c. earn no more than the cost of capital. capital. d. are not not profit profitabl able. e. 151. If you must determine determine the long-run equilibrium equilibrium output of a competitive competitive firm and you are permitted to see only one curve, which of the following curves is most helpful? a. dema emand b. marginal cost D,A D,A c. aver averag agee cost cost d. averag averagee fixed fixed cost cost


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FIGURE 8-8

152. In Figure 8-8, through which point must a horizontal horizontal demand curve pass to yield a longrun equilibrium? M,A a. A b. B c. C d. All of the above above is correct. correct. 153. In Figure 8-8, output at which point represents represents short-run but not long-run equilibrium? equilibrium? a. A M,I b. b. B c. C d. All of the above above is correct. correct.

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FIGURE 8-9

154. Figure 8-9 displays the cost cost curves of a perfectly competitive competitive firm. Profits at a price price of $10 would be approximately M,I M,I a. $1 per per unit unit.. b. $3 per unit. c. $5 per per unit unit.. d. $10 $10 per per unit unit.. 155. For the perfectly competitive competitive firm in Figure 8-9, what is the long-run price and and quantity? a. P = 4, Q = 150 150 M,A M,A b. P = 9, Q = 200 200 c. P = 10, 10, Q = 200 200 d. P = 5, Q = 150 150 156. In the long run, run, the perfectly competitive firm firm in Figure 8-9 will leave the the industry if the price falls below a. $10. M,A b. $9. c. $5. d. $2. 157. In the short run, the firm in Figure 8-9 will shut shut down if the price price falls below a. $8. b. $6. M,A c. $5. d. $1.


158. The entry of new firms firms into an industry industry will very likely a. shift shift the the industry industry supply supply curve curve to the right. right. b. cause the market price to fall. c. reduce reduce the the profits profits of existi existing ng firms firms in the the indus industry. try. E,I d. All of the the above above are correc correct. t. 159. In long-run equilibrium under under perfect competition, competition, a. the firm and and the the industry will have the same cost curves. b. only a very few firms will be earning economic profits. M,A c. the demand curves facing facing individual individual firms will will fall to the the level of minimum minimum AC. AC. d. individual firms will tend to increase their outputs. 160. Which of the following following statements concerning concerning equilibrium in the long run is not true? M,R a. Most firms earn economic economic profits profits in the long run. b. The firm can vary its plant size in the long run. c. Economic profits are eliminated eliminated as new new firms enter the the industry industry in the long run. run. d. For firms firms in lo long-ru ng-run n equilibr equilibrium, ium, P = MC = AC. AC. PERFECT COMPETITION AND ECONOMIC EFFICIENCY

161. In long-run equilibrium, equilibrium, the perfectly competitive competitive firm produces a. where where P = MC = AC. AC. b. at the lowest point on its long-run average cost curve. c. where its long-run long-run average cost cost curve is tangent tangent to its its horizontal horizontal demand curve. M,I d. All of the the above above are correc correct. t. 162. The most efficient efficient market structure in the long long run is E,R a. perfec perfectt compet competit ition ion.. b. monopolistic monopolistic competition. c. olig oligop opol oly. y. d. mo mono nopo poly ly..

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163. If government forced a firm to charge a price equal to marginal cost in a situation situation where there are scale economies, a. new firms would would enter enter the industry. industry. D,A b. the firm would would be forced forced to go bankrupt bankrupt.. c. positive positive economic economic profit profit would would grow even larger. larger. d. marginal marginal cost would would exceed exceed average average cost. cost. WHICH IS BETTER TO CUT POLLUTION—THE CARROT OR THE STICK?

164. A tax on polluting polluting firms firms M,A a. would would shift shift the LRAC LRAC curve upward. upward. b. would shift the LRAC curve downward. c. would would have have the the same same impact impact on the firm as a subsidy. subsidy. d. tends to have have the perverse effect of of increasing increasing pollution. pollution. 165. If the objective of economic policy is to decrease the the amount of pollution by an industry industry in the long run, the a. most effective policy action action would be a subsidy to firms for the reduction of emissions. M,A b. most effective policy action would be a tax on polluting firms. c. appropriate course of action for government is to do nothing. d. appropriate course of action for government government is to increase increase R&D R&D outlays to develop technology to remove the emissions from the environment. 166. A subsidy to firms intended intended to reduce pollution pollution in an industry industry would a. shift shift the LRAC curve upward. upward. b. have the same impact on the firm as a tax. c. likely likely drive drive some existing existing firms from the industry. industry. M,A d. likely have the paradoxical paradoxical effect of increasing pollution in the industry in in the long run. ESSAY QUESTIONS

167. Give a complete but concise concise definition of of the following terms. terms. a. perfec perfectt compet competit ition ion b. perfectly competitive firm’s demand curve c. shut shutdo down wn poin pointt d. long-run long-run equilibri equilibrium um in in perfect perfect competiti competition on ANSWER E, R


a.

b. c. d.

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Perfect competition is a market structure in which there are many small firms each selling a homogeneous product, with freedom of entry and exit and complete information. The perfectly competitive firm’s demand curve is horizontal, which means it can sell as much as it wishes at the prevailing market price. The shut-down point for the firm in the short run is the output point where average revenue is less than average variable cost. Long-run equilibrium for equilibrium for the perfectly competitive firm is an output level such that P = MC = AC and economic profit is zero.

168. Define the following terms and and explain their importance to the the study of economics. a. ma marg rgin inal al cost cost b. marginal revenue c. short short-ru -run n equili equilibri brium um d. supply supply curve curve of the firm firm e. econ econom omic ic prof profit it ANSWER E, R a. Marginal cost cost is the the cost to the firm of producing producing and selling an additional unit of the good. b. Marginal revenue is the amount of extra revenue the firm receives for f or producing and selling one more unit of a good. c. Short-run equilibrium occurs in the the time time period period in which some commitments commitments cannot be changed. The number of firms in the industry cannot be changed. The competitive firm will equate P to MC > AVC to choose profit-maximizing (or loss-minimizing) price and output. If price is below the minimum of AVC, the firm will minimize losses by shutting down. d. The supply supply curve for for the competitive firm is MC > AVC. If price is below the the minimum of AVC, the firm will minimize losses by shutting down. e. Economic profit equals net earnings, earnings, in the the accountant’s accountant’s sense, minus minus the the opportunity opportunity cost of capital and of any other inputs supplied by the firm’s owners. It is assumed that firms seek to maximize economic profits. In a competitive industry in the long run, economic profits are zero. 169. What are the assumptions assumptions of the model of perfect competition? competition? Explain why each is important for short-run and long-run equilibrium. ANSWER M, R There are four assumptions: 1.

Numerous small firms and customers. Each buyer and each seller is so small that each has only a negligible portion of the whole market. Therefore, none is able to control price or output of the industry.


2.

Homogeneity of product. Or, no product differentiation, including brand names or trademarks. Because the product offered by any seller is identical to that offered by any other seller, consumers do not care from which firm they buy. Therefore, no producer is able to charge a premium price.

3.

Freedom of entry and exit. New firms can enter the market with no impediments, and firms are able to leave the industry with no problems. If there are economic profits in the industry, we expect firms to enter, increasing industry supply and driving price lower.

4.

Perfect information. Each firm and each customer is well informed about the available products and prices. They are able to compare prices and seek the lowest price. The result is that the firm has no control over price and is a price taker. Market demand and market supply determine the price. The firm will maximize short-run profits by equating MR = P = MC > AVC and by producing at the quantity at which this equilibrium occurs. If P < minimum AVC, the firm will minimize losses by shutting down. In the long run, firms will enter or leave the industry based on profit opportunities, and there will be no economic profits or losses. If the price should rise or fall enough to cause economic profits or losses, there will be entry or exit of firms until economic profits of all firms in the industry are zero.

170. Of the following industries, industries, which are perfectly competitive? Of those which are not, not, why do they not fit the model? a. loca locall bank bankin ing g b. gasoline stations c. college-l college-level evel education educational al institu institution tionss d. local local radio and televisio television n e. local local farmer farmers’ s’ market market ANSWER M, I a. Local banking is not (generally) perfectly competitive. In small towns, there are at most only a few banks. In larger cities, there are more banks from which to choose. Further, banks compete on image, size, service, etc., and not always on price. Location and hours of service may vary. b. Gasoline stations are close to perfectly competitive, but many customers will shop on the basis of brand names. If so, the industry is monopolistically competitive. c. Colleges are differentiated. They are generally distinguished by size, quality of instruction, etc. This is an example of monopolistic competition. d. Local radio and television can be oligopolistic in many smaller markets and close to monopolistic competition in large markets. Differentiation is common, with different formats (talk, classical, rock, etc.). e. Local farmers’ markets are probably the closest to perfect competition on the list. Each buyer and seller is small relative to the market; produce is not usually differentiated; and all are able to shop quickly and easily to compare price and output quality.


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171. Why study perfect perfect competition, competition, if it rarely rarely exists? ANSWER E, R Perfect competition is the circumstance where the market performs best, demonstrating Adam Smith’s “invisible hand” in action. Each firm, acting in its own self-interest—the pursuit of maximum profit—ends up acting in society’s best interest; products are produced and sold at minimum average cost in the long run. Also, even if the conditions of the model are not fulfilled, firms may still act as if the assumptions held. So the model’s predictive power may extend beyond the cases of agricultural and stock markets. 172. Draw a graph illustrating illustrating the relationship relationship between the the demand curve of the perfectly competitive firm and the perfectly competitive industry. Label all curves and axes correctly. ANSWER M, I The diagram of the firm and industry should look like Figure 8-1 in the text. The firm’s demand curve should be horizontal at the industry equilibrium price. 173. Why doesn’t a competitive competitive firm reduce its price below the industry price to increase sales? ANSWER E, A A competitive firm can sell all it wishes at the going industry price; that is the meaning of a horizontal demand curve. There would be no point to charging less if one can sell all one wants at a higher price. Furthermore, such a policy would result in losses in the long run, where industry price results in zero economic profits and any lower price would result in losses. 174. Why doesn’t a perfectly competitive competitive firm charge a price slightly higher than the industry industry price in order to earn extra profit? ANSWER E, A A perfectly competitive firm is producing a product that is identical to the output of each of its competitors. Additionally, it is only one firm of many in the market. Thus, no buyer would pay a price above the industry rate in order to buy from one particular firm; instead, the consumer would simply buy from one of the many other firms. 175. What makes the the demand curve of the perfectly competitive competitive firm uniquely uniquely different from that of firms in other kinds of market structures? ANSWER E, R The perfectly competitive firm’s demand curve is horizontal, which means it can sell as much as it wants at the market price. This is possible because each firm under perfect competition is so insignificant relative to the market as a whole that it has no influence over price; it is a price taker. 176. What is the difference between the short short run and the long run as economists define define the two? ANSWER E, R


The short run is a period of time within which at least one resource is fixed. It could be a commitment for a rental lease, for example. The short run is also a period too short for new firms to enter the industry or for firms currently in the industry to exit. For the long-run period, all resources may vary; hence, all costs are variable costs. New firms may enter the industry and old firms may exit. 177. Draw a graph illustrating a competitive competitive firm in short-run equilibrium that is earning earning an economic profit. Be sure to label all curves and axes correctly. ANSWER D, I The diagram should look like Figure 8-2 in the text. Note that price must be higher than the minimum of average cost. 178. If a firm has short-run losses, will it stay open? open? Under what conditions conditions will a firm close in the short run? Explain. ANSWER D, A The firm suffers losses if P < AC so that revenue does not cover costs. The firm will stay open if P > minimum of AVC. If the firm shuts down, revenue falls to zero but fixed costs continue as obligations of the firm. Therefore, if P > minimum of AVC, the firm can cover its variable (avoidable) obligations and a portion of fixed (unavoidable) obligations. Such a decision cuts losses, so that it is more profitable to produce than to close. However, if P < minimum of AVC, the firm should close. Revenue is insufficient to cover variable (avoidable) costs, much less cover some portion of fixed (unavoidable) costs. Loss minimization in this case requires closing down. 179. Explain the reasoning reasoning behind the shutdown rules. rules. When is it appropriate to operate with a loss? ANSWER M, I 1. The firm will make make a profit if if total revenue (TR) exceeds total total cost (TC). (TC). In that case, case, it should not plan to shut down either in the short run or in the long run. 2. The firm should should continue to to operate in the short run if TR exceeds short-run variable variable cost (TVC). It should plan to close in the long run if TR is less than TC. The first rule requires no explanation. The second rule relies on the distinction between fixed and variable costs. The firm can avoid variable costs in the short run by shutting down. However, it is unable to avoid fixed costs by shutting down. If a firm shuts down, its losses will equal the amount of its fixed costs. If revenue exceeds total variable cost (or, equivalently, if price exceeds the minimum of average variable cost), the firm should operate, pay all variable costs and some portion of fixed costs, to minimize losses. 180. If there are no profits profits in competitive equilibrium, equilibrium, why do firms produce? produce? How can they stay in business? ANSWER E, I


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The “no profits” conclusion of competition refers to economic profits—there is no excess rate of return to the typical firm. However, each firm is able to earn sufficient accounting profits to cover the opportunity cost of invested factors and to continue operating. The source of the confusion is failing to distinguish between accounting and economic profits. 181. A firm sells in a competitive market in which price is $10. Its marginal marginal cost is 2 + .5Q. Determine the profit-maximizing level of output. ANSWER M, A The solution requires equating P = MC to determine Q: P = 10 = MC = 2 + .5Q 10 = 2 + .5Q 8 = .5Q Q = 16 182. A firm sells in a competitive market in which price is $12. Its marginal marginal cost is 6 + .25Q. Determine the profit-maximizing level of output. ANSWER M, A The solution requires equating P = MC to determine Q: P = 12 = MC = 6 + .25Q 12 = 6 + .25Q 6 = .25Q Q = 24 183. Describe the process that would would occur in the long run in a competitive industry if there were economic profits. Illustrate this with a diagram. ANSWER M, I The diagram should look like Figure 8-7 in the text. If there are economic profits, firms will enter the industry. The industry supply will increase and the price will fall. As the price falls, the profits of each firm will fall. The (representative) firm will therefore cut output, moving downward on its marginal cost curve. The process of entry will end when each firm is at the bottom of average cost so that there are no economic profits. 184. Draw a graph showing the typical competitive competitive firm losing money but continuing continuing to operate. Explain why the firm continues to operate rather than shut down. ANSWER M, I


Figure 8-10 shows price (= MR) above minimum AVC but below minimum AC. The firm is losing money but less money than if it shuts down. Since price exceeds AVC, it is covering all its variable costs and has funds left over, which can cover a portion of fixed cost. If the firm shuts down, it loses all its fixed cost. FIGURE 8-10


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185. Graphically show a firm earning earning a profit; shade the appropriate profit rectangle. Explain Explain how the profit formula represented by the rectangle is analogous to TR – TC. ANSWER E, A Figure 8-11 shows price (= MR) above minimum AC. The firm operates at the quantity Q c where P = MC. The shaded rectangle is (P c – AC c)Qc. This is simply a restatement of TR – TC, since TR = P × Q and TC = AC × Q. FIGURE 8-11


186. A firm’s minimum AC is $10, its minimum AVC AVC $7. Show this firm’s short-run supply curve, explaining how you obtained it. ANSWER M, I Draw a U-shaped AC and AVC, with Q at minimum AVC at a smaller level than for AC (Figure 8-12). MC passes through each of these minimum points. The firm’s short-run supply is MC above minimum AVC. Below minimum AVC, the firm produces zero. Only when P exceeds minimum AVC will the firm find it worthwhile to operate; below minimum AVC the firm is better off shutting down and losing its fixed cost. FIGURE 8-12


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187. If the typical firm’s firm’s minimum average variable cost cost is $10 at an output output of 50 units, if marginal cost is $20 at 70 units, and there are 1,000 firms in the industry, sketch supply curves for the typical firm and for the industry as a whole. ANSWER M, I For the firm, plot two supply points corresponding to P = $10 and Q = 50, P = $20 and Q = 70 (Figure 8-13). For the industry, multiply the Q’s by 1,000, so that industry Q = 50,000 at P = $50 and industry Q = 70,000 at P = $20. FIGURE 8-13

188. There are currently 1,000 firms firms in a competitive competitive industry. Minimum long-run long-run average cost is $80 and price $100. Explain what will happen to price, profit, and the number of firms in this industry over time. ANSWER E, I Price exceeds minimum long-run average cost, so that firms are earning an economic profit. This will induce additional entry over time. As supply increases (rightward shift), price will fall to minimum long-run average cost of $80. Economic profit will drop to zero. 189. How does a firm that is losing money in the short short run decide whether to shut down or continue to produce to minimize its losses? ANSWER M, A The firm should continue to produce in the short run if TR exceeds TVC; if TR falls below TVC, the firm should shut down.


190. Sally Rand owns a ceiling fan company. company. She sells 1,000 ceiling fans at $50 each. Each fan costs her $20. She uses her own money to buy the fans; she withdraws the money from her savings account where it earns 5 percent interest. Before going into the ceiling fan business, she worked as a fan-dancer at $25,000 a year. Should Sally remain in business? ANSWER M, A If her economic profit is at least zero, Sally should stay in business. Her TR = $50,000 and her total accounting cost is $20,000, for an accounting profit of $30,000. She forgoes interest on savings of $20,000 (.05) = $1,000 as well as forgone earnings of $25,000. This leaves $4,000 in economic profit, so she should stay in business. 191. Explain how the the short-run supply supply curve of the competitive competitive firm is derived. ANSWER M, A Since the firm is either minimizing losses or maximizing profit in the short run if it produces where MC = P above minimum AVC for any price above minimum AVC, the quantity can simply be read off the MC curve. Thus the MC curve above minimum AVC becomes the firm’s short-run supply curve. 192. Explain why Adam Adam Smith believed that that competitive markets markets are a key component of achieving the gains from the invisible hand. ANSWER E, R Adam Smith believed that individuals acting in their own self-interest would end up acting in society’s best interest. This process is borne out by competition, in which firms pursuing maximum profit end up producing a good at the lowest possible AC and selling it at a price equal to the minimum LRAC. 193. Explain how the the short-run industry industry supply curve for a perfectly competitive competitive market is derived. ANSWER E, A At any given price, the quantities supplied by individual firms are simply added. The resulting curve is a horizontal summation of all the individual firms’ supply curves. 194. Explain why taxes on pollutants pollutants reduce pollution while while subsidies to firms cutting their pollutants actually increase pollution. ANSWER M, I Taxes cause an increase in cost and a leftward shift of supply. Output decreases and there is less pollution. Subsidies cause individual firms to cut their emissions, but they also induce additional firms into the market. Since costs of production decrease, the new equilibrium output will increase. 195. Show what happens happens to the industry industry equilibrium when new firms enter a perfectly competitive market in the long run. ANSWER M, A


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The diagram of the process should be similar to Figure 8-7 in the text. The industry supply curve shifts outward and industry price falls. 196. What is the relationship relationship between the long-run industry industry supply curve and the short-run supply curve in a perfectly competitive market? ANSWER M, A The long-run industry supply curve evolves from the short-run supply curve. As new firms enter, the short-run supply curve shifts toward its long-run position. Also, as shortrun fixed cost commitments become variable, the short-run cost curves become the longrun cost curve. 197. To own a taxicab taxicab in New York City, you must own own a medallion. medallion. New York City regulates the number of official cabs by limiting the number of medallions. Explain why the New York cab industry is not competitive by reviewing the four conditions necessary for competition. competition. NYC violates which one? ANSWER E, I Production is by many firms, each selling an identical product. There are no barriers to entry or exit, and consumers and producers have perfect information. The medallion is a barrier to entry to new firms, which can only enter the industry by buying a medallion from existing taxicab owners. 198. What is the difference between the accountant’s accountant’s concept of of profit and the economist’s view of profit? ANSWER E, A Accountants tend to include in TC contractual costs only. The economist measures TC as the cost of all the firm’s inputs, including the opportunity cost of the capital or any other inputs, such as labor, provided by the firm’s owners. Accounting profit is generally larger than economic profit, so that positive accounting profit may correspond to zero economic profit. 199. Illustrate the the cost curves and average revenue revenue (demand) curve for the perfectly perfectly competitive firm in long-run equilibrium. ANSWER E, I The illustration should look like Figure 8-9(a) in the text. 200. Why do economists consider consider perfect competition to be the the most efficient market structure? ANSWER E, R Perfect competition is the most efficient market structure because, in the long run, each firm in the market will be producing at its minimum average cost, or per-unit cost (see Figure 8-9a in the text, for example). This means that consumers get desired goods and services at the lowest possible prices, and also that the firms are economizing on society’s scarce resources to the greatest extent possible.

Economics

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