1. Chapter 14
Questions and Answers

2. Question 1
Refer to Table The price and quantity relationship in the table is most likely that faced by a firm in a:
a. price discriminating monopoly market.
b. single price monopoly market.
c. oligopoly market.
d. monopolistically competitive market.
e. perfectly competitive market.

3. Question 1 Answer
E. perfectly competitive market.
Competitive Markets

4. What is a Competitive Market?
The revenue of a competitive firm
Maximize profit
Total revenue minus total cost
Total revenue = price times quantity = P ˣ Q
Proportional to the amount of output
Average revenue
Total revenue divided by the quantity sold

5. What is a Competitive Market?
The revenue of a competitive firm
Marginal revenue
Change in total revenue from an additional unit sold
For competitive firms
Average revenue = Price
Marginal revenue = Price

6. Question 2
Which of the following is NOT a characteristic of a perfectly competitive market?
a. Firms are price takers.
b. Firms have difficulty entering the market.
c. There are many sellers in the market.
d. There are many buyers in the market.
e. Goods offered for sale are homogeneous.

7. Question 2 Answer B: Firms have difficulty entering the market
Competitive Markets

8. What is a Competitive Market?
Market with many buyers and sellers
Trading identical products
Each buyer and seller is a price taker
Firms can freely enter or exit the market

9. Question 3
Refer to Table At which quantity of output is marginal revenue equal to marginal cost?
a. 2
b. 3
c. 6
d. 8
e. 9

10. Question 3 Answer
C: 6
Profit Maximization

11. What is a Competitive Market?
Marginal revenue
Change in total revenue from an additional unit sold
For competitive firms
Average revenue = Price
Marginal revenue = Price

12. A simple example of profit maximization Maximize profit
Produce quantity where total revenue minus total cost is greatest
Compare marginal revenue (MR) with marginal cost (MC)
If MR > MC – increase production
If MR < MC – decrease production

13. Question 4 If the firm finds that its marginal cost is $11, it should
a. increase production to maximize profit.
b. increase the price of the product to maximize profit.
c. advertise to attract additional buyers to maximize profit.
d. reduce production to increase profit.
e. keep production at the current level.

14. Question 4 Answer D: reduce production to increase profit.
Profit Maximization

15. Question 5
If the market price is P3, in the short run, the perfectly competitive firm will earn:
a. positive economic profits.
b. negative economic profits but will try to remain open.
c. negative economic profits and will shut down.
d. zero economic profits.
e. break-even profits.

16. Question 5 Answer
B: negative economic profits but will try to remain open.
Supply Curve

17. Profit Maximization& Competitive Firm’s Supply Curve
The marginal-cost curve and the firm’s supply decision
Marginal Cost (MC) curve – upward sloping
Average Total Cost (ATC) curve – U-shaped
MC curve crosses the ATC curve at the minimum of ATC curve
Price = Average Revenue = Marginal Revenue

18. Profit Maximization& Competitive Firm’s Supply Curve
The marginal-cost curve and the firm’s supply decision
Three general rules for profit maximization:
If MR > MC - firm should increase output
If MC > MR - firm should decrease output
If MR = MC - profit-maximizing level of output

19. Profit Maximization& Competitive Firm’s Supply Curve
The marginal-cost curve and the firm’s supply decision
Marginal-cost curve
Determines the quantity of the good the firm is willing to supply at any price
Is the supply curve

20. Question 6
Refer to Figure Which of the four prices corresponds to a perfectly competitive firm earning negative economic profits in the short run and shutting down?
a. P1 only
b. P2 only
c. P3 only
d. P4 only
e. P3 and P4

21. Question 6 Answer
D: P4 only
Supply Curve

22. Question 7
Refer to Figure When market price is P3, a profit-maximizing firm’s total revenue
a. can be represented by the area P3 x Q3.
b. can be represented by the area P3 x Q2.
c. can be represented by the area (P3-P2) x Q3.
d. can be represented by the area (P3-P2) x Q2.
e. is zero.

23. Question 7 Answer B: can be represented by the area P3 x Q2.
Total Revenue

24. Question 8
Refer to Figure When market price is P3, a profit-maximizing firm’s profit
a. can be represented by the area P3 x Q3.
b. can be represented by the area P3 x Q2.
c. can be represented by the area (P3-P2) x Q3.
d. can be represented by the area P3 x Q1.
e. is zero.

25. Question 8 Answer
E: is zero
Profit

26. Question 9
Refer to Figure When market price is P3, a profit-maximizing firm’s total costs
a. can be represented by the area P2 x Q2.
b. can be represented by the area P3 x Q2.
c. can be represented by the area (P3-P2) x Q3.
d. can be represented by the area P3 x Q3.
e. are zero.

27. Question 9 Answer B: can be represented by the area P3 x Q2.
Total Cost

28. Question 10 Output TC 0 $5 1 $10 2 $12 3 $15 4 $24 5 $40
0 $5
1 $10
2 $12
3 $15
4 $24
5 $40
If the market price is $4, this firm will
a. produce two units in the short run and exit in the long run.
b. produce three units in the short run and exit in the long run.
c. produce four units in the short run and exit in the long run.
d. shut down in the short run and exit in the long run.
e. produce five units in the short run and the long run.

29. Question 10 Answer
B: produce three units in the short run and exit in the long run.
Losses

30. Question 11 Output TC 0 $1 1 $6 2 $9 3 $10 4 $17 5 $26
0 $1
1 $6
2 $9
3 $10
4 $17
5 $26
What is the lowest price at which this firm might choose to operate?
a. $1
b. $2
c. $3
d. $4
e. $5

31. Question 11 Answer
C: $3
Supply Curve

32. Profit Maximization& Competitive Firm’s Supply Curve
Shutdown
Short-run decision not to produce anything during a specific period of time because of current market conditions
Firm still has to pay fixed costs
Exit
Long-run decision to leave the market
Firm doesn’t have to pay any costs

33. Profit Maximization& Competitive Firm’s Supply Curve
The firm’s short-run decision to shut down
TR = total revenue
VC = variable costs
Firm’s decision:
Shut down if TR<VC (P<AVC)
Competitive firm’s short-run supply curve
The portion of its marginal-cost curve that lies above average variable cost

34. Question 12
Refer to Figure Assume that the market starts in equilibrium at point A in panel (b). An increase in demand from D0 to D1 will result in:
a. a new market equilibrium at point D.
b. an eventual increase in the number of firms in the market and a new long-run equilibrium at point C.
c. rising prices and falling profits for existing firms in the market.
d. falling prices and falling profits for existing firms in the market.
e. a new long-run market equilibrium at point B.

36. Question 12 Answer
B: an eventual increase in the number of firms in the market and a new long-run equilibrium at point C.
Long-run Supply Curve

37. Supply Curve in a Competitive Market
Short run: market supply with a fixed number of firms
Short run – number of firms is fixed
Each firm – supplies quantity where P = MC
For P > AVC: supply curve is MC curve
Market supply
Add up quantity supplied by each firm

38. Supply Curve in a Competitive Market
Long run: market supply with entry and exit
Long run – firms can enter and exit the market
If P > ATC – firms make positive profit
New firms enter the market
If P < ATC – firms make negative profit
Firms exit the market
Process of entry and exit ends when
Firms still in market: zero economic profit (P = ATC)
Because MC = ATC: Efficient scale
Long run supply curve – perfectly elastic
Horizontal at minimum ATC

39. Supply Curve in a Competitive Market
Why do competitive firms stay in business if they make zero profit?
Profit = total revenue – total cost
Total cost – includes all opportunity costs
Zero-profit equilibrium
Economic profit is zero
Accounting profit is positive

40. Supply Curve in a Competitive Market
A shift in demand in the short run & long run
Market – in long run equilibrium
P = minimum ATC
Zero economic profit
Increase in demand
Demand curve – shifts outward
Short run
Higher quantity
Higher price: P > ATC – positive economic profit

41. Supply Curve in a Competitive Market
A shift in demand in the short run & long run
Because: positive economic profit in short run
Long run – firms enter the market
Short run supply curve – shifts right
Price – decreases back to minimum ATC
Quantity – increases
Because there are more firms in the market
Efficient scale

42. Supply Curve in a Competitive Market
Why the long-run supply curve might slope upward
Some resource used in production may be available only in limited quantities
Increase in quantity supplied – increase in costs – increase in price
Firms may have different costs
Some firms earn profit even in the long run
Long-run supply curve
More elastic than short-run supply curve

43. Profit Maximization& Competitive Firm’s Supply Curve
Firm’s long-run decision to exit/enter a market
Exit the market if
Total revenue < total costs; TR < TC
Same as: P < ATC
Enter the market if
Total revenue > total costs; TR > TC
Same as: P > ATC
Competitive firm’s long-run supply curve
The portion of its marginal-cost curve that lies above average total cost

44. FRQ 1
Using correctly labeled side-by-side graphs for a market and a firm, graph a firm earning short-run economic profits. Can this scenario be maintained in the long run? Explain.

45. FRQ 1 Answer
In a competitive market where firms are earning economic profits, new firms will have an incentive to enter the market. This entry will expand the number of firms, increase the quantity of the good supplied, and drive down prices and profits. Entry will cease once firms are producing the output level where price equals the minimum of the average-total-cost curve, meaning that each firm earns zero economic profits in the long run.

46. FRQ 1 Graphs

47. FRQ 2
Using cost curve analysis, explain the derivation of a perfectly competitive firm’s short-run supply curve.

48. FRQ 2 Answer
A perfectly competitive firm’s short-run supply curve is the rising portion of its marginal cost curve above the variable cost curve. The supply curve for a perfectly competitive firm is represented by the various quantities the firm would willingly put on the market at each possible alternative price. In the short run, a perfectly competitive firm would operate and produce where MC=P, as long as that occurs above average variable cost. If the price were below average variable cost, the firm would shut down in the short run.