Economics (McConnell), AP Edition, 20th Edition Chapter (7)

Chapter 11: Pure Competition in the Long Run Multiple-Choice Questions 1. In pure competition, which of the following are true in the long run? I. Individual firms have the freedom to enter or exit the industry. II. Individual firms have control over the market price of their product. III. Individual firms’ output decisions are based on their costs and the market price. IV. Individual firms’ profits attract entry, while losses prompt exit. (A) I only (B) II only (C) I, II, and IV only (D) I, III, and IV only (E) I, II, III, and IV (D) Individual firms in pure competition do not have control over the market price of their product. The market price is set by the industry, not by any individual firm. Firms have the freedom of entry and exit, make decisions based on their costs and the market price for their product, and expand, contract, enter, or exit based on profits or losses. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: The Long-Run Adjustment Process in Pure Competition 2. In the long run, a purely competitive firm will only operate at a point where (A) positive economic profit is generated (B) only accounting profit is generated (C) negative economic profit is generated (D) average total cost is at a minimum (E) average variable cost is at a minimum (D) In the long run, a purely competitive firm will operate where MR=MC at ATC minimum. At that point the firm has covered all costs, explicit and implicit. Accounting costs do not include implicit costs, such as the opportunity costs to the owners for their use of resources they have provided. For a firm to remain in an industry in the long run, it must recover all costs including implicit costs. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Long-Run Equilibrium 3. In pure competition, the freedom to enter or exit an industry ensures that, in the long run, firms earn I. positive economic profits II. only normal returns III. sufficient revenues to cover only explicit costs IV. sufficient revenues to cover explicit and implicit costs (A) I only (B) II only (C) II and III only (D) II and IV only (E) I and IV (D) Competitive firms in the long run will generate sufficient revenues to cover their explicit and implicit costs and thereby earn zero economic profit. This occurs when MR=MC at ATC minimum. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Long-Run Equilibrium 4. If the market price for a perfectly competitive industry yields economic losses in the short run, existing firms in the industry will exit. The result will be that (A) the industry supply curve will shift leftward, the quantity demanded will decrease and the market price in the long run will increase (B) the industry supply curve will shift leftward, demand will decrease, and the market price in the long run will decrease (C) the industry supply curve will shift leftward and the market price in the long run will not change (D) the quantity supplied will decrease and the market price in the long run will increase (E) demand and supply will both decrease and the market price in the long run will not change (A) As firms exit, the industry supply curve will shift leftward, the market price will increase, and the quantity demanded will decrease. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: The Long-Run Adjustment Process in Pure Competition 5. In the long run, which of the following are true in a competitive industry? I. Firms can expand or contract productive capacity. II. Firms face substantial fixed costs. III. Firms can freely enter and exit. IV. Firms are driven by incentives based on profits and losses. (A) I only (B) II only (C) I and III only (D) I, III, and IV only (E) II, III, and IV only (D) In the long run, firms in competitive markets have no fixed costs. They are free to enter or exit, expand or contract productive capacity, with each of those decisions based on profits and losses. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: The Long Run in Pure Competition 6. If firms in a competitive, constant-cost industry are earning positive economic profits in the short run, then in the long run Industry Industry Market Firms Demand Supply Price (A) Enter Constant Increases Decreases (B) Enter Increases Increases Uncertain (C) Enter Decreases Increases Decreases (D) Exit Decreases Decreases Increases (E) Exit Constant Decreases Increases (A) If there are short-run positive economic profits in a constant-cost competitive industry, existing firms will expand productive capacity and new firms will enter, causing a rightward shift in the short-run industry supply curve (supply increases) until the firms in the industry earn only zero economic profit. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: The Long Run in Pure Competition 7. The long-run supply curve for a constant-cost industry is (A) upward-sloping because changes in output affect resource prices (B) upward-sloping because changes in output affect per-unit resource costs (C) upward-sloping because firms will produce and sell more only if market price increases (D) horizontal because industry expansion and contraction will not affect resource costs (E) horizontal because industry expansion and contraction will affect resource costs (D) In a constant-cost industry, changes in industry output will not affect either resource prices or production costs. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Long-Run Supply for a Constant-Cost Industry 8. In a competitive, constant-cost industry, the industry long-run supply curve is (A) elastic but not perfectly elastic (B) inelastic but not perfectly inelastic (C) perfectly elastic (D) perfectly inelastic (E) unit elastic (C) In the long run, the supply curve for a constant-cost industry is perfectly horizontal; changes in output will not affect resource costs or production costs. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Long-Run Supply for a Constant-Cost Industry 9. Assuming a competitive, increasing-cost industry, an increase in market demand in the long run will result in Market Price Resource Prices Average Total Costs (A) Constant Increase Increase (B) Increase Increase Constant (C) Increase Increase Increase (D) Decrease Decrease Decrease (E) Uncertain Increase Increase (C) The long-run industry supply curve for an increasing-cost industry will slope upward. If the industry increases output, resources prices will increase, each firm’s average total cost curve will increase, and the market price will increase. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Long-Run Supply for an Increasing-Cost Industry 10. Entrepreneurs in a perfectly competitive industry attempt to increase their short-run profits by I. reducing production costs II. improving technology III. raising prices IV. developing new products (A) I only (B) III only (C) II and IV only (D) I, II, and IV only (E) I, II, III, and IV (D) Because individual firms in a perfectly competitive industry are too small to affect prices, they can only increase profit by reducing their costs, increasing productivity, or innovating or inventing new products. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Technological Advance and Competition 11. Allocative efficiency is identified as the output where (A) Marginal Revenue = Demand (B) Price = Marginal Cost (C) Average Total Cost = Average Variable Cost (D) Average Total Cost = Marginal Cost (E) Average Variable Cost = Price (B) Allocative efficiency occurs where the supply (MC above AVC) equals demand (price for a competitive firm). Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Efficiency and Perfect Competition Book Section: Allocative Efficiency: P = MC 12. Purely competitive industries have which of the following characteristics? I. Resources will be transferred from firms generating economic losses. II. Firms will earn zero economic profit in the long run. III. Firms will be able to operate in the short run as long as revenues cover variable costs. IV. Firms will shut down in the long run if market price is less than average total cost. (A) I only (B) II only (C) III only (D) I, II, and IV only (E) I, II, III, and IV (E) All these characteristics describe purely competitive industries and their firms. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: The Long-Run Adjustment Process in Pure Competition Questions 13 and 14 assume firms in constant-cost industries are engaged in pure competition. 13. Each firm will have (A) marginal revenue that equals marginal cost at average variable cost minimum (B) marginal cost that equals marginal revenue at average fixed cost minimum (C) marginal revenue that equals marginal cost at average total cost minimum (D) marginal revenue that equals marginal cost above average total cost minimum (E) marginal cost that equals marginal revenue at a level below market price (C) In the long run, these firms will operate with zero economic profit where marginal revenue (MR) equals marginal cost (MC) at average total cost (ATC) minimum. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Productive Efficiency: P = Minimum ATC 14. For these firms and industries, which of the following will be true? I. These industries will be productively efficient. II. These industries will generate optimal allocative efficiency. III. Because marginal cost equals marginal revenue at the minimum of average total cost, some economic inefficiency occurs. IV. These firms will compete in markets that maximize producer and consumer surpluses. (A) I only (B) III only (C) II and IV only (D) I, II, and IV only (E) I, II, III, and IV (D) Because firms in purely competitive, constant-cost industries can expand, contract, enter, or exit freely, these industries will have all of the characteristics above except economic inefficiency in the long run. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Efficiency and Perfect Competition Book Section: Pure Competition and Efficiency For questions 15-16, assume the firm competes in a purely competitive, constant-cost industry and that the firm is able to cover all of its variable costs. 15. The firm finds that its average revenue is greater than its marginal cost. To maximize profit, this firm will (A) increase output and lower the price (B) decrease output and raise the price (C) increase output knowing the price remains constant (D) keep output constant but lower the price (E) decrease output knowing the price remains constant (C) This firm is operating in a pure competitive industry where {[P=MR] > MC}>AVC. To maximize profit, this firm must increase output until MC=MR. An increase in output by this firm will have no impact on the market price in the industry. Therefore, the price will remain constant. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Profit Maximization in the Long Run 16. The firm finds that its marginal revenue is less than its marginal cost. To maximize profit, this firm will (A) increase output and lower the price (B) decrease output and raise the marginal cost (C) increase output knowing the price remains constant (D) decrease output and raise the price (E) decrease output knowing price will remain constant (E) This firm is operating in a pure competitive industry where {[P=MR] < MC}>AVC. This firm must decrease output until MR=MC. Any decrease in output by this firm will have no impact on the market price in the industry. Therefore, the price will remain constant. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: The Long-Run Adjustment Process in Pure Competition 17. In the graph above, the long-run supply curve reflects an industry in which (A) expansion and contraction will not affect resource prices (B) expansion will increase resource prices (C) expansion will decrease resource prices (D) contraction will increase resource prices (E) expansion will increase resource prices but contraction will not impact resource prices (B) The industry supply curve above illustrates an increasing-cost, long-run supply curve in which industry expansion will increase resource prices, and industry contraction will decrease resource prices. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Long-Run Supply for an Increasing-Cost Industry 18. Given the graph above, a contraction in the industry would I. help the industry and the firms II. decrease costs per unit for the industry and the firms III. increase costs per unit for the industry and the firms (A) I only (B) III only (C) I and II only (D) I and III only (E) I, II, and III (B) This industry faces a long-run supply curve that slopes downward. That means that as the industry and firms expand, per-unit costs will decrease. However, if the industry and firms contract, per-unit costs will increase and both the industry and the firms will be hurt by the increased per-unit costs of production. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Long-Run Supply for a Decreasing-Cost Industry 19. In long-run equilibrium for a competitive firm and market in which all costs and benefits have been included, which of the following is true? (A) Consumer surplus must be greater than producer surplus, maximizing allocative efficiency. (B) Producer surplus must be greater than consumer surplus, maximizing productive efficiency. (C) Consumer surplus and producer surplus are maximum and efficiency is optimal. (D) While neither consumer nor producer surplus is maximized, efficiency is optimal. (E) While consumer and producer surpluses are maximized, efficiency is not necessarily optimal. (C) These firms will be producing the maximum output and selling at the lowest possible price in the long run. This will occur where marginal revenue equals marginal cost at the minimum average total cost. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Efficiency and Perfect Competition Book Section: Pure Competition and Efficiency 20. If competitive firms in the short run have positive economic profit where marginal cost equals marginal revenue I. optimal allocative efficiency has been achieved II. optimal productive efficiency has been achieved III. the sum of consumer and producer surplus is maximized IV. long-run adjustments will create optimal efficiency with the sum of consumer and producer surplus maximized (A) I only (B) I and II only (C) I and III only (D) II and III only (E) IV only (E) Only at the level where MC=MR=ATC at ATC minimum will efficiency and the sum of consumer and producer surpluses be maximized. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Efficiency and Perfect Competition Book Section: Pure Competition and Efficiency 21. If consumer demand for the product in a perfectly competitive industry increases, which effects will occur for the individual firm in the short run? I. The product price will increase. II. The firm will incur a loss at its current output. III. The firm will increase output. (A) I only (B) II only (C) II and III only (D) I and III only (E) I, II, and III (D) Increased industry demand pushes up the price, which causes the firm's marginal revenue curve to shift upward. In the short run, the firm increases output to the point where MC = MR again. Because the price is now higher than the ATC, the firm experiences an economic profit in the short run. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Dynamic Adjustments 22. If a perfectly competitive firm's variable cost increases, all of the following occur in the short run EXCEPT (A) the firm's average total cost will increase (B) the firm's marginal cost will increase (C) the firm's average fixed cost will increase (D) the firm's output will decrease (E) the firm will experience a short-run loss (C) An increase in variable cost increases the firm's average total cost and marginal cost, but it has no effect on average fixed cost. The firm decreases its output to minimize its loss where MC = MR, and the loss is illustrated with the new ATC positioned above the price. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Short-Run Costs Book Section: Dynamic Adjustments 23. In a perfectly competitive industry in which firms are achieving short-run economic profit (A) firms will enter the industry (B) firms will increase the product price (C) industry output will decrease (D) firms will exit the industry (E) the government will increase taxes (A) Economic profit draws firms into the industry. Firms that cannot affect product price are price-takers, and the short-run economic profit would lead firms to increase output rather than reducing it. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: The Long Run in Pure Competition 24. Assume that a perfectly competitive firm finds that its property tax (a lump-sum cost) increases. In the short run, the firm will (A) not change its output (B) increase output to where marginal cost equals the new average total cost (C) reduce output to where marginal cost equals the new average total cost (D) increase output to where the new marginal cost equals marginal revenue (E) reduce output to where the new marginal cost equals marginal revenue (A) A lump-sum cost only affects average fixed cost and average total cost. Because marginal cost is not affected, the firm's output does not change. Difficulty: Hard Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and the Long Run Book Section: Dynamic Adjustments 25. Assume profit-maximizing firms in a perfectly competitive industry are earning only a normal rate of return. In that condition, all of the following occur EXCEPT (A) firms can cover their full explicit and implicit costs (B) firms have no incentive to enter or exit the industry (C) both productive and allocative efficiency are achieved (D) consumer and producer surplus are maximized (E) firms earn a positive economic profit (E) In long-run equilibrium, firms earn only a normal profit. Those profits will cover the explicit costs and the implicit costs. These implicit costs include the opportunity cost of the entrepreneur as well as the owner’s resources that are used by the firm. However, because there is no economic profit, there will be no incentive for firms to enter or exit. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: Pure Competition and Efficiency Free-Response Question The table below indicates the short-run costs for Cheryl’s Cupcakes, a profit-maximizing firm in a perfectly competitive industry in long-run equilibrium. Output Produced (Boxes) Total Cost 0 20 1 30 2 35 3 38 4 44 5 51 6 60 7 70 8 90 (a) Calculate the marginal cost of producing the second box of cupcakes. (b) Calculate the average total cost of producing 4 boxes of cupcakes. (c) Cheryl’s Cupcakes receives a price of $10 per box of cupcakes. Indicate how many boxes of cupcakes the firm should sell to maximize its profit. Explain how you reached that conclusion. (d) Assume cupcakes are a normal good. Explain the effect of a decrease in consumer incomes on each of the following. (i) The cupcake industry (ii) The price Cheryl’s Cupcakes will receive for its product (iii) The quantity of cupcakes produced by Cheryl’s Cupcakes (iv) The short-run economic profit or loss incurred by Cheryl’s Cupcakes (v) The industry's long-run adjustment Free-Response Explanation 9 points (1 + 1 + 2 + 5) (a) 1 point: 1 point is earned for stating that the marginal cost is $5 ($35 - $30). (b) 1 point: 1 point is earned for stating that the average total cost is $11 ($44 / 4). (c) 2 points: 1 point is earned for stating that Cheryl’s Cupcakes maximizes profit at 7 boxes. 1 point is earned for explaining that the marginal revenue equals the marginal cost at that output. (d) 5 points: 1 point is earned stating that the industry demand decreases. 1 point is earned for stating that the price of the product decreases. 1 point is earned for stating that the firm's output decreases. 1 point is earned for stating that the firm will incur a short-run loss. 1 point for explaining that in the long run, firms will exit the industry. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run and in the Long Run Book Section: The Long-Run Adjustment Process in Pure Competition