A perfectly competitive firm will shut down if the price falls below its average total cost. Do you ...

(Answer to Q. 1)  A perfectly competitive firm will not shut down as far as the price is above its average variable cost. If the price is below the ATC but above the AVC, the firm can cover part of its fixed cost if it continues to operate. If the firm shuts down, it incurs an economic loss equal to total fixed cost. So as long as the price is above the AVC, the firm will have a smaller economic loss if it continues to operate than if it shuts down.

(Answer to Q. 2)  The additional selling costs from product differentiation and marketing increase consumer choice by providing variety. This benefits society and weighs in favor of the efficiency of monopolistic competition. However, selling costs can add to the product's price. Also, at times the product differentiation is more apparent than real. These factors harm society and count against the efficiency of monopolistic competition.

(Answer to Q. 3)  C

(Answer to Q. 4)  Adverse selection is a tendency for people to enter into agreements in which they can use their private information to their own advantage and to the disadvantage of the less informed party. For example, if a car dealership offers its salespeople a fixed wage, it will attract lazy salespeople. Hardworking salespeople will prefer not to work for this dealership because they can earn more by working a dealership that pays by results.

(Answer to Q. 5)  In monopolistic competition, there are a large number of small firms producing differentiated products. Each firm's output is a substitute for other firms' output; therefore demand for any firm's product is very elastic. If firms can further differentiate their product in the eyes of the consumer, they might be able to both increase demand and decrease demand elasticity, at least temporarily. In this case, the firm could then charge a higher price and, temporarily at least, make an economic profit. This differentiation occurs through innovation, product development and marketing, which contribute to selling costs.

(Answer to Q. 6)  D

(Answer to Q. 7)  B

(Answer to Q. 8)  B

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