Economics (McConnell), AP Edition, 20th Edition Chapter (32)

Chapter 10: Pure Competition in the Short Run Multiple-Choice Questions 1. Which of the following statements best describes a perfectly competitive market? I. A large number of firms exist in the industry. II. Products are differentiated. III. Firms can easily enter or exit the industry. (A) I only (B) II only (C) I and III only (D) II and III only (E) I, II, and III (C) In perfect competition, many firms compete in the industry and produce a homogeneous product. Further, in perfect competition, there are no barriers to entry or exit. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Perfect Competition Book Section: Pure Competition: Characteristics and Occurrence 2. Because the perfectly competitive firm is a price-taker, its demand curve is (A) upward-sloping (B) downward-sloping (C) horizontal (D) vertical (E) dependent on the marginal cost (C) The industry demand curve is downward-sloping. The market equilibrium price set in the industry becomes the perfectly elastic demand for the firm. Because the firm has no power to change price in the market, it can sell all of the products it makes at the same price. 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: Demand as Seen by a Purely Competitive Seller 3. In order to maximize profit, the firm should produce where (A) Marginal Revenue = Price (B) Marginal Cost = Marginal Revenue (C) Marginal Cost = Average Variable Cost (D) Price = Average Variable Cost (E) Average Revenue = Price (B) The MC = MR rule is the same for firms in all market structures. The firm should continue to produce as long as the marginal revenue from selling a unit is greater than or equal to the marginal cost of producing that unit. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Profit Maximization: MR=MC Rule Book Section: Profit Maximization in the Short Run: Marginal-Revenue–Marginal-Cost Approach 4. At long-run equilibrium for the perfectly competitive firm, the marginal cost is equal to all of the following EXCEPT (A) average total cost (B) average revenue (C) price (D) marginal revenue (E) average variable cost (E) For the perfectly competitive firm, marginal revenue and price are equal on the demand curve. The firm maximizes profit where MC = MR and it reaches productive efficiency by producing where MC = ATC at that same point. The average variable cost curve will be below the ATC, so it is the only curve not equal to all of the others at the profit-maximizing output. 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: Profit Maximization in the Short Run: Marginal-Revenue–Marginal-Cost Approach 5. At a particular output, a perfectly competitive firm's price is $10, marginal cost is $11, average total cost is $12, and average variable cost is $8. The firm should (A) increase output to maximize profit (B) continue production at its current level of output to maximize output (C) decrease output to minimize loss, but keep producing in the short run (D) raise the product price to $11 to maximize profit (E) shut down (C) At that output, marginal cost is greater than marginal revenue, so the firm should decrease output. The firm is incurring a loss because price is lower than the average total cost. Since the price is higher than the average variable cost, the firm should continue to produce in the short run. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Short-Run Supply and Shutdown Decision Book Section: Loss-Minimizing Case 6. If a firm incurs losses, it should continue to produce as long as the price covers the (A) average variable cost (B) average fixed cost (C) average total cost (D) marginal cost (E) marginal revenue (A) If the firm can recover all of its variable costs, it should continue to produce because it can use any additional revenues toward its fixed costs. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Short-Run Supply and Shutdown Decision Book Section: Loss-Minimizing Case 7. If a firm is producing 10 products which it can sell for a price of $5 per unit, and the marginal cost of producing the 11th product is $3, which of the following statements is true? (A) The total cost of producing 11 units is $5 greater than producing 10 units. (B) The total revenue of selling 11 units equals the total revenue of selling 10 units. (C) The total profit from selling 11 units is $2 more than the total profit from selling 10 units. (D) The marginal revenue from selling the 11th unit is $3. (E) The marginal cost of producing the 11th unit is greater than the marginal revenue from producing it. (C) The marginal revenue of producing the next unit is $5, and the marginal cost of producing the next unit is $3, so the total profit increases by $2. Difficulty: Easy Style: Applied AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: Profit-Maximizing Case 8. An industry characterized by a large number of firms that produce identical products and have no control over price is (A) perfect competition (B) monopolistic competition (C) oligopoly (D) pure monopoly (E) natural monopoly (A) A perfectly competitive firm is such a small part of the industry that it has no market power. Because the firm cannot differentiate its product and any competitor can easily enter the industry, it has no means by which to gain market power. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Perfect Competition Book Section: Four Market Models 9. In a perfectly competitive market, what is the slope of the demand curves for the industry and the individual firm? Industry Demand Individual Firm Demand (A) Horizontal Horizontal (B) Vertical Vertical (C) Downward-Sloping Horizontal (D) Horizontal Downward-Sloping (E) Downward-Sloping Downward-Sloping (C) In the industry, market supply and demand determine the product price. The individual firm must accept the product price as a perfectly elastic (horizontal) demand curve. 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: Demand as Seen by a Purely Competitive Seller 10. Assume Kenny is a farmer who sells soybeans in a perfectly competitive industry. If the industry equilibrium price for soybeans is $14 per bushel and Kenny sets his price at $15 per bushel, Kenny’s (A) marginal revenue will increase (B) accounting profit will increase (C) economic profit will increase (D) total revenue will increase (E) total revenue will decrease (E) In a perfectly competitive industry, the products are identical and individual firms have no control over the price. If Kenny tries to charge a price higher than market equilibrium, consumers will instead buy the soybeans of other producers, reducing Kenny’s total revenue. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms and Markets in the Short Run Book Section: Pure Competition: Characteristics and Occurrence 11. The income a firm earns from selling one additional product is the (A) marginal revenue (B) total revenue (C) total profit (D) marginal profit (E) economic profit (A) The cost of production must be subtracted from revenue to determine the profit. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Profit Maximization: MR=MC Rule Book Section: Average, Total, and Marginal Revenue 12. Using the total-cost—total-revenue approach, assume that a firm calculates that its break-even point is 200 products. This firm will not produce fewer than 200 products because at a lower output, the firm would (A) only earn a low level of economic profit (B) not earn a normal profit (C) earn no revenue (D) incur increasing costs of production (E) be subject to government regulation (B) At the break-even point, the firm earns a normal profit, but not an economic profit. If the firm produces fewer products, it cannot cover the implicit costs of production. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: Profit Maximization in the Short Run: Total-Revenue—Total-Cost Approach Use the table for a competitive firm below to answer questions 13-15. Total Product (Q) Total Cost (TC) ($) Average Total Cost (ATC) ($) Average Variable Cost (AVC) ($) Marginal Cost ($) Total Revenue (TR) ($) Marginal Revenue (MR) ($) 0 100.00 1 190.00 190.00 90.00 81.00 2 270.00 135.00 85.00 162.00 3 340.00 113.33 80.00 243.00 4 400.00 100.00 75.00 324.00 5 470.00 94.00 74.00 405.00 6 550.00 91.67 75.00 486.00 7 640.00 91.43 77.14 567.00 8 750.00 93.75 81.25 648.00 9 880.00 97.78 86.67 729.00 10 1030.00 103.00 93.00 810.00 13. At zero units of total product, the total fixed cost for this firm is (A) 0 (B) 90 (C) 100 (D) 190 (E) indeterminable (C) At zero units of output, all costs are fixed. At any level of output, (ATC–AVC) x TP = TFC. In this table, TFC is $100.00. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Short-Run Costs Book Section: Profit Maximization in the Short Run: Marginal-Revenue–Marginal-Cost Approach 14. Between three and four units of total product, the marginal cost and marginal revenue are Marginal Cost Marginal Revenue (A) Rising and greater than ATC Rising (B) Falling and less than ATC Falling (C) Less than ATC Constant (D) Greater than ATC Constant (E) Minimum Maximum (C) The price this firm faces is a constant industry market price of $81.00. For a firm in a perfectly competitive market, marginal revenue is constant and equals average revenue and price. If ATC is falling, the MC must be less than ATC. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Short-Run Costs Book Section: Profit Maximization in the Short Run: Marginal-Revenue–Marginal-Cost Approach 15. Assuming units of output are not divisible, the shutdown point for this firm in the short run occurs where (A) total output is 5 units, where MC=AVC at AVC minimum (B) total output is 7 units, where MC=ATC at ATC minimum (C) total output is 7 units, where MC>ATC (D) total output is 8 units, where MR<AVC (E) total output is 6 units, where MR=MC at ATC minimum (D) To operate in the short run, a firm must cover at least all of its variable costs or where MR=AVC. At the market price of $81, at seven units of output, MR>AVC and the firm is able to cover all of its variable costs. If the firm were to produce the eighth unit of output, the firm would be unable to cover all of its variable costs ($81.25) and would shut down in the short run to minimize losses. Difficulty: Hard Style: Applied AP Economics Curricular Requirement Microeconomics: Short-Run Supply and Shutdown Decision Book Section: Shutdown Case Use the graph for a competitive firm below to answer questions 16-17. 16. If the market price is $71, this competitive firm will (A) produce in the short run, but if price does not rise to $93, it will shut down in the long run (B) produce in the short run, as it can cover all variable costs and some of its fixed costs (C) cease production and sell what it has already produced to minimize losses (D) produce in the short run, as it can just cover all of its variable costs but none of fixed costs (E) produce in the short run, as it can cover its explicit costs but not its implicit costs (C) This firm must shut down because it cannot cover all of its variable costs. It will sell what it has already produced to minimize losses. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Short-Run Supply and Shutdown Decision Book Section: Shutdown Case 17. At a market price of $93, this firm (A) has normal profit and is able to cover only its accounting costs (B) has normal profit, but is unable to fully cover the explicit and implicit costs it faces (C) has positive economic profit as it can cover its explicit and implicit costs (D) has positive accounting profit but negative economic profit, being unable to cover all implicit costs (E) has normal profit, but is just able to cover all of its explicit and implicit costs (E) At $93, this firm can cover all of its fixed and variable costs. Those costs include both the explicit and implicit costs associated with the resources used in production. When a firm can just cover its fixed and variable costs, that firm has a normal profit and zero economic profit. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Accounting versus Economic Profits Book Section: Profit-Maximizing Case Use the graph for a competitive firm below to answer questions 18-21. 18. At a product price of “0h”, this firm would maximize profit by producing at an output of (A) “0n” (B) “0p” (C) “0r” (D) “0s” (E) “0t” (D) At output “0s”, the marginal revenue equals the marginal cost, which is the definition of profit maximization. Difficulty: Easy Style: Applied AP Economics Curricular Requirement Microeconomics: Profit Maximization Book Section: Marginal Cost and Short-Run Supply 19. At price “0f”, which of the following is true? I. The firm has a positive economic profit of “feug” and a total fixed cost of “guvj”. II. The firm has a total cost of “gut0” and a fixed cost of “guvj”. III. The firm is in a short-run position. (A) I only (B) II only (C) III only (D) I and II only (E) I, II, and III (E) This competitive firm has a positive economic profit because total revenue (“fet0”) is greater than total cost (“gut0”). This firm’s total fixed cost is “guvj” (total cost minus total variable cost). But because this firm faces perfect competition, firms will enter and expand competition, driving the price down until no further positive economic profits can be obtained. This firm is in a short-run position. 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: Marginal Cost and Short-Run Supply 20. This firm’s short-run shutdown would occur when price is below (A) average total cost (B) average fixed cost (C) average variable cost (D) marginal cost (E) average revenue (C) At a price below average variable cost, this firm cannot operate in the short run. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Short-Run Supply and Shutdown Decision Book Section: Shutdown Case 21. The portion of the firm’s marginal cost curve that is above the average variable cost curve is the firm’s (A) short-run supply curve (B) short-run demand curve (C) long-run supply curve (D) long-run demand curve (E) shutdown point (A) The firm maximizes profit where MC=MR, so it will supply products at the output where marginal revenue meets the marginal cost curve. The firm will not produce at any point where it cannot cover its average variable cost, so the short-run supply curve only consists of the points above the AVC curve. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Short-Run Supply and Shutdown Decision Book Section: Marginal Cost and Short-Run Supply 22. If a firm in a competitive industry is facing an increase in the cost of heating fuel, this firm will find that (A) its marginal cost, average fixed cost, and average total cost curves have shifted upward (B) its marginal cost, average variable cost, and average total cost curves have shifted upward (C) its marginal cost, average fixed cost, and average total cost curves have shifted downward (D) its marginal cost, average variable cost, and average total cost curves have shifted downward (E) its average fixed cost and average total cost curves have shifted upward (B) Heating fuel costs are variable costs, so the marginal cost, average variable cost, and average total cost curves will shift upward. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Short-Run Costs Book Section: Marginal Cost and Short-Run Supply 23. Because the perfectly competitive firm is a price taker, the price equals (A) average variable cost (B) marginal revenue (C) average fixed cost (D) total revenue (E) total cost (B) Because the individual firm must accept the price set in the market, every product is sold at the same price. That price is the marginal revenue the firm earns from selling each product. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Behavior of Firms in the Short Run and in the Long Run Book Section: Average, Total, and Marginal Revenue 24. The MR=MC rule for profit maximization applies to firms engaged in I. perfect competition II. monopolistic competition III. oligopoly IV. monopoly (A) I only (B) I and II only (C) III and IV only (D) II and IV only (E) I, II, III, and IV (E) Firms in all market structures maximize profit by producing at the output where the marginal cost equals the marginal revenue. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Microeconomics: Profit Maximization: MR=MC Rule Book Section: Profit Maximization in the Short Run: Marginal-Revenue—Marginal-Cost Approach 25. For the perfectly competitive firm, the MR=MC rule can also be stated as (A) TR=TC (B) MC=ATC (C) TR=MR (D) P=MC (E) MR=ATC (D) Because the individual firm must accept the market price, the price and the marginal revenue are equal. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Microeconomics: Profit Maximization: MR=MC Rule Book Section: Profit Maximization in the Short Run: Marginal-Revenue—Marginal Cost Approach Free-Response Questions 1. Assume Joslyn Farm is a profit-maximizing firm in the perfectly competitive corn industry, which is in long-run equilibrium. (a) Using correctly labeled side-by-side graphs for the corn industry and Joslyn Farm, show each of the following. (i) Industry price and output (ii) Joslyn Farm's price and output (b) Assume the government offers a per-unit subsidy to corn farmers. On your graphs from part (a), show the effects of the subsidy on each of the following in the short run. (i) Joslyn Farm's output. Explain. (ii) The area of profit or loss for Joslyn Farm. Explain. (c) Explain how the industry will return to long-run equilibrium and why this effect occurs in perfectly competitive markets. 2. Assume SamKat, Inc. sells lemonade at a county fair, surrounded by dozens of other food stands selling the very same lemonade. (a) In what type of market structure is SamKat operating? (b) If SamKat increases its product price above the industry equilibrium price, what will happen to its total revenue? Explain. (c) Assume the cost of lemons increases for all lemonade stands in the industry. (i) Explain the effect of the cost increase on SamKat's output. (ii) Explain the effect on SamKat's short-run profit or loss. (iii) Under what conditions will SamKat continue to produce in the short run? Free-Response Explanations 1. 10 points (4 + 4 + 2) (a) 4 points: 1 point is earned for correctly identifying equilibrium price and quantity for the industry. 1 point is earned for drawing a horizontal line linking the industry price to Joslyn Farm's marginal revenue curve. 1 point is earned for labeling the firm's demand curve as price and showing output where MC = MR. 1 point is earned for correctly placing the average total cost curve with its minimum at the output where MC = MR. (b) 4 points: 1 point is earned for showing Joslyn Farm's output will increase. 1 point is earned for explaining that the firm produces where MC = MR; because MC shifted downward, they now cross at a greater output. 1 point is earned for showing Joslyn Farm's area of profit. 1 point is earned for explaining that because the new ATC is below the price (or marginal revenue or average revenue), the firm is earning an economic profit. (c) 2 points: 1 point is earned for explaining that firms enter the industry. 1 point is earned for explaining that profits draw the firms into the industry. Difficulty: Medium Style: Applied AP Economics Curricular Requirement Microeconomics: Firm behavior and market structure:  Perfect competition Book Section: Marginal Cost and Short-Run Supply 2. 6 points (1 + 2 + 3) (a) 1 point: 1 point is earned for identifying the market structure as perfect competition. (b) 2 points: 1 point is earned for stating that SamKat's total revenue will fall to zero. 1 point is earned for explaining that customers will purchase the substitute product from another firm. (c) 3 points: 1 point is earned for stating that SamKat's output will decrease. 1 point is earned for stating that SamKat will incur a short-run loss. 1 point is earned for explaining that SamKat will continue to produce in the short run as long as marginal revenue is greater than or equal to average variable cost. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Microeconomics: Firm behavior and market structure:  Perfect competition Book Section: Marginal Cost and Short-Run Supply