Chapter 14. Firms in Competitive Markets.

1. Suppose all firms selling ice cream in Tinseltown are earning economic profits of $12,000 per month. In the long run, we would expect

a. entry into the market and economic profits to be eliminated.Correct. Economic profits draw more firms and increase supply and reduce prices.

b. entry into the market and economic profits to increase.Incorrect. More entry means more supply and lower prices and profits.

c. exit from the market and economic profits to be eliminated.Incorrect. Economic profits give incentives for more firms to enter.

d. exit from the market and economic profits to increase.Incorrect. Economic profits give incentives for more firms to enter.

2. The firm in the diagram operates in a perfectly competitive market. If price is $15, what level of output should the firm produce in order to maximize profits?

a. 1,000. Incorrect. At output of 3,000, marginal cost equals marginal revenue/price of $15.

b. 2,000. Incorrect. At output of 3,000, marginal cost equals marginal revenue/price of $15.

c. 3,000. Correct. At output of 3,000, marginal cost equals marginal revenue/price of $15.

d. 4,000. Incorrect. At output of 3,000, marginal cost equals marginal revenue/price of $15.

3. Suppose the firm in the diagram operates in a competitive market. If price is $10, we know that:

a. in the short run, the firm is earning an economic profit. Incorrect. Price is below ATC and therefore, costs will be greater than revenues.

b.

in the short run, the firm will shut down. Incorrect. At $10, the firm is covering its variable costs.

c. in the short run, the firm is earning zero economic profit. Incorrect. Price is below ATC and therefore, costs will be greater than revenues.

d. in the short run, the firm is earning an economic loss. Correct. Price is below ATC and therefore, costs will be greater than revenues.

4. Suppose the firm in the diagram operates in a perfectly competitive market. If price is $11, the firm will earn an economic profit of:

a. $88,550. Incorrect. The per unit profit of $2.50 will be earned on 8050 units produced where marginal cost equals marginal revenue of $11.

b. $68,425. Incorrect. The per unit profit of $2.50 will be earned on 8050 units produced where marginal cost equals marginal revenue of $11.

c. $48,400. Incorrect. The per unit profit of $2.50 will be earned on 8050 units produced where marginal cost equals marginal revenue of $11.

d. $20,125. Correct. The per unit profit of $2.50 will be earned on 8050 units produced where marginal cost equals marginal revenue of $11.

5. Economic losses for perfectly competitive firms

a. will continue in the long run for a few inefficient firms.Incorrect. After some firms exit, losses will be eliminated.

b. will shift the industry demand function rightward.Incorrect. Losses will cause industry supply to shift leftward.

c. will cause firms to exit the industry in the long run.Correct. Long run losses mean that firms can never expect to earn profits.

d. will result in a decrease in long-run equilibrium price.Incorrect. Losses will cause exit, supply decrease, and price increases.

6. In the diagram, the long-run equilibrium price and quantity are

a. $11 and 11,020, respectively. Incorrect. Long-run equilibrium will occur at the minimum point on the average total cost curve.

b. $8 and 6,050, respectively. Correct. This is the minimum point on the average total cost curve.

c. $4 and 4,000, respectively. Incorrect. Long-run equilibrium will occur at the minimum point on the average total cost curve.

d. $2 and firms 2,000, respectively.Incorrect. Long-run equilibrium will occur at the minimum point on the average total cost curve.

7. The short-run supply curve for a firm is

a. its marginal revenue curve.Incorrect. Only above the average variable cost curve is the range where firms will operate.

b. its average total cost curve.Incorrect. Firms operate along the marginal cost curve.

c. the portion of its marginal cost curve that lies above average variable cost.Correct. Firms would shut down at points below the average variable cost curve.

d. the portion of its marginal cost curve that lies above average total cost.Incorrect. Firms operate if they cover variable costs. They don't need to cover total costs.

8. At Paula's Pizza, the marginal revenue of the last pizza produced is $12. The marginal cost of the last pizza produced is $10. In order to increase profits, Paula should

a. increase output.Correct. As long as marginal revenue exceeds marginal costs, total profits are rising if output increases.

b. decrease output.Incorrect. As long as marginal revenue exceeds marginal costs, total profits are rising if output increases.

c. not change output. Incorrect. As long as marginal revenue exceeds marginal costs, total profits are rising if output increases.

d. offer a different variety of pizza. Incorrect. As long as marginal revenue exceeds marginal costs, total profits are rising if output increases.

9. The firm in the diagram below should shut down if price is

a. P1.

Correct. At price P1, price is below average variable costs and revenues will not cover variable costs.

b. P2. Incorrect. At price P1, price is below average variable costs and revenues will not cover variable costs.

c. P3. Incorrect. At price P1, price is below average variable costs and revenues will not cover variable costs.

d. P4. Incorrect. At price P1, price is below average variable costs and revenues will not cover variable costs.

10. When a perfectly competitive firm produces eight units of output, it receives total revenue of $200. The price per unit is

a. $25. Correct. Perfect competition means price to the firm does not change and will be a constant amount, in this case $200/8 = $25.

b. greater than $25. Incorrect. Perfect competition means price to the firm does not change and will be a constant amount, in this case $200/8 = $25.

c. less than $25. Incorrect. Perfect competition means price to the firm does not change and will be a constant amount, in this case $200/8 = $25.

d. somewhere between $25 and $30. Incorrect. Perfect competition means price to the firm does not change and will be a constant amount, in this case $200/8 = $25.

11. A perfectly competitive firm is producing notebooks for $1.00 each. If the firm produces 1,200 notebooks, its total revenue will be

a. $12,000. Incorrect. For a perfectly competitive firm, price is constant at the market price. In this case the constant price of $1.00 times the amount, 1200, yields total revenue of $1200.

b. $1,200. Correct. For a perfectly competitive firm, price is constant at the market price. In this case the constant price of $1.00 times the amount, 1200, yields total revenue of $1200.

c. $120. Incorrect. For a perfectly competitive firm, price is constant at the market price. In this case the constant price of $1.00 times the amount, 1200, yields total revenue of $1200.

d. 10 cents. Incorrect. For a perfectly competitive firm, price is constant at the market price. In this case the constant price of $1.00 times the amount, 1200, yields total revenue of $1200.

12. Suppose all firms in the bagel industry are earning zero economic profits. Demand for bagels decreases. We know that

a. in the short, run firms in the industry will earn an economic profit.Incorrect. If profits are zero, a demand decrease will decrease prices so that losses will occur.

b. in the short, run firms in the industry will earn an economic loss.Correct. If profits are zero, a demand decrease will decrease prices so that losses will occur.

c. in the long run, firms will enter the industry.Incorrect. The losses caused by the decrease in demand will cause firms to exit.

d. in the long run, industry supply will increase.Incorrect. The losses caused by the decrease in demand will cause firms to exit and industry supply to decrease.

13. The firm in the figure will make an economic profit when price is

a.

P1. Incorrect. Profits occur when prices are above average total costs. In this diagram, that occurs at price P3.

b. P2. Incorrect. Profits occur when prices are above average total costs. In this diagram, that occurs at price P3.

c. above P3. Correct. Profits occur when prices are above average total costs. In this diagram, that occurs at price P3.

d. below P2. Incorrect. Profits occur when prices are above average total costs. In this diagram, that occurs at price P3.

14. Which of the following statements is not true?

a. In the long run in a competitive market, firms operate at the efficient scale.Incorrect. They operate at the minimum average cost.

b. In the long run in a competitive market, the market supply curve can be represented as a horizontal line.Incorrect. Price is equal to single amount equal to firms’ minimum average costs.

c. In the long run in a competitive market, price equals average variable cost.Correct. In the long run, all costs are variable and price equals average total costs.

d. In order to maximize profits, a firm in a competitive market should operate at the point where marginal revenue and marginal cost are equal.Incorrect. This will occur at the minimum point on the average cost curve.

15. The long-run supply curve in a competitive market may slope upward if

a. the price of resources increases as output increases.Correct. If resource prices rise, then the average cost curves will shift upwards.

b. the price of resources decreases as output increases.Incorrect. If resource prices fall, then average costs will fall and supply will slope downward.

c. the price of resources does not change as output increases.Incorrect. If resource prices do not change, then the supply curve will remain horizontal.

d. all firms in the industry have identical costs.Incorrect. If resource prices do not change, then the supply curve will remain horizontal

16. If a competitive firm's marginal revenue at the current level of production is $8 per unit and its marginal cost is $9 per unit, the firm should

a. increase output. Incorrect. If marginal cost is above marginal revenue, then output is causing increased losses, so output should be decreased.

b. decrease output. Correct. If marginal cost is above marginal revenue, then output is causing increased losses, so output should be decreased.

c. not change output. Incorrect. If marginal cost is above marginal revenue, then output is causing increased losses, so output should be decreased.

d. exit the industry. Incorrect. If marginal cost is above marginal revenue, then output is causing increased losses, so output should be decreased.

17. If an industry's long-run supply curve is upward sloping, we can conclude that resource prices for the industry tend to

a. increase as industry output increases.Correct. If resource prices are increasing, average costs are increasing and the long-run supply curve will slope upward.

b. decrease as industry output increases.Incorrect. If resource prices are increasing, average costs are increasing and the long-run supply curve will slope upward.

c. remain constant as industry output increases.Incorrect. If resource prices are increasing, average costs are increasing and the long-run supply curve will slope upward.

d. first increase and then decrease as output increases.

Incorrect. If resource prices are increasing, average costs are increasing and the long-run supply curve will slope upward.

18. In the diagram, the firm's long-run supply curve is represented by

a. all points above point A.Incorrect. Point C is the minimum point on the average total cost curve and the long-run equilibrium point.

b. all points above point B.Incorrect. Point C is the minimum point on the average total cost curve and the long-run equilibrium point.

c. all points above point C.Correct. Point C is the minimum point on the average total cost curve and the long-run equilibrium point.

d. all points between C and D.Incorrect. Point C is the minimum point on the average total cost curve and the long-run equilibrium point.

19. At current production levels, marginal revenue at Sally's Sandals is $10. Marginal cost is $10. We know that Sally's

a. should increase output.Incorrect. Any change in output from this level would reduce total profits.

b. is maximizing profits (or minimizing losses).Correct. Any change in output from this level would reduce total profits.

c. is maximizing its costs in the short run.Incorrect. This is the point where profits are being maximized.

d. should decrease output.Incorrect. Any change in output from this level would reduce total profits.

20. Which of the following most closely describes a perfectly competitive market?

a. large number of buyers, one seller, perfect information, homogenous productionIncorrect. One seller is a monopoly.

b. large number of buyers and sellers, same product for all firms, free entry and exit from the marketCorrect. These conditions will yield one price for all firms and all buyers.

c. differentiated product, many sellers, easy entry into a marketIncorrect. Differentiated products will cause different prices.

d. differentiated or identical products, many sellers, easy entry, perfect informationIncorrect. Differentiated products will cause different prices.

21. Jason's Jams wants to know the cost of producing a typical jar of jam. The company should examine

a. marginal cost.Incorrect. Average total cost is the same as average per unit cost of production.

b. average total cost.Correct. Average total cost is the same as average per unit cost of production.

c. marginal revenue.Incorrect. Average total cost is the same as average per unit cost of production

d. average revenue.Incorrect. Average total cost is the same as average per unit cost of production

22. Brooke wants to know how her revenues will change if she increases production in her plant. Brooke should examine

a. total revenue. Incorrect. The key phrase in the question is " how her revenues will change." In economics, change means the marginal value.

b. average revenue. Incorrect. The key phrase in the question is " how her revenues will change." In economics, change means the marginal value.

c. marginal revenue. Correct. The key phrase in the question is " how her revenues will change." In economics, change means the marginal value.

d. marginal profit. Incorrect. The key phrase in the question is " how her revenues will change." In economics, change means the marginal value.

23. Suppose a firm's average variable cost is $13, average total cost is $20 and the price of output is $12. In this case,

a. the firm will shut down.Correct. The firm will shut down because its revenue of $12 does not cover its variable cost of $13.

b. the firm will stay open and will lose its fixed cost.Incorrect. The firm will shut down because its revenue of $12 does not cover its variable cost of $13.

c. the firm will stay open and will lose its variable cost.Incorrect. The firm will shut down because its revenue of $12 does not cover its variable cost of $13.

d. the firm will stay open since it is earning an economic profit.Incorrect. The firm will shut down because its revenue of $12 does not cover its variable cost of $13.

24. If input prices remain constant as industry output increases in the long run, the long-run supply curve

a. is vertical. Incorrect.

If input prices remain constant, prices will be a constant amount illustrated by a horizontal supply curve.

b. slopes upward. Incorrect. If input prices remain constant, prices will be a constant amount illustrated by a horizontal supply curve.

c. is horizontal. Correct. If input prices remain constant, prices will be a constant amount illustrated by a horizontal supply curve.

d. slopes downward. Incorrect. If input prices remain constant, prices will be a constant amount illustrated by a horizontal supply curve.

25. Assume that a perfectly competitive industry is initially in long-run equilibrium at point E in the figure. If the demand curve shifts permanently to D2, the path to the new long-run equilibrium will be:

a. E to C, then back to E. Incorrect. The increase in demand will initially raise the price to C and then entry of new firms will reestablish long run equilibrium back at price F.

b. E to H, then back to E. Incorrect. The increase in demand will initially raise the price to C and then entry of new firms will reestablish long run equilibrium back at price F.

c. E to C, then on to F.

Correct. The increase in demand will initially raise the price to C and then entry of new firms will reestablish long run equilibrium back at price F.

d. E to H, then on to F. Incorrect. The increase in demand will initially raise the price to C and then entry of new firms will reestablish long run equilibrium back at price F.

26. Suppose that the economy is initially in long-run equilibrium at E in the figure and then moves to a new long-run equilibrium at F. Which of the following is true as part of the industry adjustment process?

a. Some firms will temporarily make economic profits.Correct. The price will initially rise above the horizontal long-run cost curve signaling the existence of temporary profits.

b. Some firms will temporarily incur economic losses.

Incorrect. The price will initially rise above the horizontal long-run cost curve signaling the existence of temporary profits.

c. Some firms will exit the industry.Incorrect. The price will initially rise above the horizontal long-run cost curve signaling the existence of temporary profits.

d. Price will temporarily fall below $10.Incorrect. The price will initially rise above the horizontal long-run cost curve signaling the existence of temporary profits.

27. In long-run equilibrium, a perfectly competitive firm produces the output level that minimizes

a. marginal cost.Incorrect. All costs are variable in the long run, so there is only one average cost curve where equilibrium will settle at its minimum point.

b. average fixed cost.Incorrect. All costs are variable in the long run, so there is only one average cost curve where equilibrium will settle at its minimum point.

c. average variable cost.Incorrect. All costs are variable in the long run, so there is only one average cost curve where equilibrium will settle at its minimum point.

d. average total cost. Correct. All costs are variable in the long run, so there is only one average cost curve where equilibrium will settle at its minimum point.

28. Which of the following is NOT a characteristic of a competitive market.

a. All sellers offer a similar product.Incorrect. This is a condition for a competitive market.

b. There are many buyers.Incorrect. This is a condition for a competitive market.

c. There are many sellers.Incorrect. This is a condition for a competitive market.

d. Firms are restricted from entering the market.Correct. A competitive market has free entry for all firms.

29. The firm in the diagram is

a. earning an economic profit.Incorrect.

The marginal revenue (price) is below average cost and, therefore, total revenues are below total costs and losses will result.

b. earning an economic loss.Correct. The marginal revenue (price) is below average cost and, therefore, total revenues are below total costs and losses will result.

c. earning zero economic profit.Incorrect. The marginal revenue (price) is below average cost and, therefore, total revenues are below total costs and losses will result.

d. at its long-run equilibrium position.

Incorrect. The marginal revenue (price) is below average cost and, therefore, total revenues are below total costs and losses will result.

30. Which of the following is the shut-down rule for a firm in competitive market? Shut down if

a. P < ATC. Incorrect. If price is below average variable costs, firms will lose more than their fixed cost losses.

b. P < FC. Incorrect. If price is below average variable costs, firms will lose more than their fixed cost losses.

c. P < AVC. Correct. If price is below average variable costs, firms will lose more than their fixed cost losses.

d. P < AFC. Incorrect. If price is below average variable costs, firms will lose more than their fixed cost losses.

31. Which of the following should NOT be considered when making decisions in the short run?

a. Implicit costs. Incorrect. This is a cost that must be considered in the short run.

b. Hidden costs. Incorrect. This is a cost that must be considered in the short run.

c. Variable costs.Incorrect. This is a cost that must be considered in the short run.

d. Sunk costs. Correct. In the short-run, the decision to operate or not depends only on covering short-run variable costs, not fixed costs.

32. When new firms continue to be attracted to an industry:

a. the average cost of production must be declining.

Incorrect. The existence of profits is an incentive for more firms to enter and try to earn similar profits.

b. firms in the industry must be earning economic profits.Correct. The existence of profits is an incentive for more firms to enter and try to earn similar profits.

c. firms in the industry must be suffering losses.Incorrect. The existence of profits is an incentive for more firms to enter and try to earn similar profits.

d. the industry is in equilibrium.

Incorrect. The existence of profits is an incentive for more firms to enter and try to earn similar profits.

33. When firms in an industry are incurring losses,

a. new firms will be drawn into the industry, thereby driving down the average cost of production.Incorrect. The existence of losses will cause some firms to exit so they can eliminate their losses.

b. new firms will be drawn into the industry, thereby raising price.Incorrect. The existence of losses will cause some firms to exit so they can eliminate their losses.

c. some firms will leave the industry in the long run.Correct. The existence of losses will cause some firms to exit so they can eliminate their losses.

d. industry demand and industry supply cannot be equal.

Incorrect. The existence of losses will cause some firms to exit so they can eliminate their losses.

34. Suppose the diagram depicts the situation of all firms in an industry. In the long run we would expect

a. price to decrease.Incorrect. The existence of losses will cause some firms to exit, supply to decrease and prices to rise.

b. firms to enter the industry.Incorrect. At the current price that is below average costs, losses are being earned and some firms will have an incentive to exit the industry.

c. market supply to increase.Incorrect. At the current price that is below average costs, losses are being earned and some firms will have an incentive to exit the industry.

d. market supply to decrease.Correct. At the current price that is below average costs, losses are being earned and some firms will have an incentive to exit the industry.

35. Under conditions of perfect competition,

a. a firm must lower price in order to sell additional units of output.

Incorrect. In perfect competition, firms are so small relative to the market that each firm's output has not effect on market price.

b. a firm can sell all the output it wants at the market price.Correct. In perfect competition, firms are so small relative to the market that each firm's output has not effect on market price.

c. a firm must raise price in order to sell additional units of output.Incorrect. In perfect competition, firms are so small relative to the market that each firm's output has not effect on market price.

d. firms in the market produce a dissimilar product.Incorrect. Perfect competition means all firms sell an identical product.

36. Under conditions of perfect competition,

a. P > MR. Incorrect. In perfect competition, price does not change so each additional sale, the marginal revenue does not change either and stays equal to price.

b. P < MR. Incorrect. In perfect competition, price does not change so each additional sale, the marginal revenue does not change either and stays equal to price.

c. P = MR. Correct. In perfect competition, price does not change so each additional sale, the marginal revenue does not change either and stays equal to price.

d.

P = ATC. Incorrect. In perfect competition, price does not change so each additional sale, the marginal revenue does not change either and stays equal to price.

37. According to the diagram, what is the lowest price the firm would require to produce in the short run?

a. $10. Incorrect. $20 is the lowest price that can cover average variable costs and cause the firm to operate.

b. $20. Correct. $20 is the lowest price that can cover average variable costs and cause the firm to operate.

c. $30. Incorrect. $20 is the lowest price that can cover average variable costs and cause the firm to operate.

d. $45.

Incorrect. $20 is the lowest price that can cover average variable costs and cause the firm to operate.

38. What price must the firm receive to earn zero economic profit?

a. $10. Incorrect. $45 is the only price that covers average total cost and thus causes total revenues to equal total costs.

b. $20. Incorrect. $45 is the only price that covers average total cost and thus causes total revenues to equal total costs.

c. $30. Incorrect. $45 is the only price that covers average total cost and thus causes total revenues to equal total costs.

d. $45. Correct. $45 is the only price that covers average total cost and thus causes total revenues to equal total costs.

39. At its current level of output, Sammy's Shirts has marginal revenue of $30. Marginal cost is $29. If the company wants to maximize profit, it should

a. not change output. Incorrect. An increase in output will add $30 to revenue and $29 to costs and, thus, $1 to total profits.

b. increase output. Correct. An increase in output will add $30 to revenue and $29 to costs and, thus, $1 to total profits.

c. decrease output. Incorrect. An increase in output will add $30 to revenue and $29 to costs and, thus, $1 to total profits.

d. layoff some of its workers. Incorrect. An increase in output will add $30 to revenue and $29 to costs and, thus, $1 to total profits.

40. If a firm is earning zero economic profit,

a. it should exit the industry.Incorrect. It should remain because it is covering all costs.

b. it is also earning zero accounting profit.Incorrect. Economic profits also cover implicit costs that are not part of accounting costs.

c. it is earning an accounting loss.Incorrect. Economic profits also cover implicit costs that are not part of accounting costs.

d. it is earning positive accounting profit.Correct. Economic profits also cover implicit costs that are not part of accounting costs.