CHAPTER 9: PURE COMPETITION

In this chapter you will learn:

 The names and main characteristics of the four basic market models.
 The conditions required for purely competitive markets.

 How purely competitive firms maximize profits or minimize losses.

 Why the marginal-cost curve and supply curve of competitive firms are identical.

 How industry entry and exit produce economic efficiency.

 The differences between constant-cost, increasing-cost, and decreasing-cost industries.

 How long-run competitive equilibrium results in economic efficiency.

9.1 Allocative Efficiency

Allocative efficiency, the idea that society is provided the right mix of goods, comes from the theory of Pareto optimality.
Named for its creator, Vilfredo Pareto (1848-1923), Pareto optimality is described as a condition where no one can be
made better off without making someone else worse off. For the optimal allocation of goods and services to occur, Pareto
argued that three conditions had to be met. First, there must be an optimal distribution of goods, meaning that goods are
divided amongst people in a way that maximizes total satisfaction. The second condition is the optimal technical allocation
of resources. Like the notion of productive efficiency, society must produce its goods and services using the least costly
combination of input. Third, there must be optimal quantities of the different outputs produced. For this to occur,
quantities of each good must be produced up to the point where the marginal benefit equals the marginal cost.

Born in Paris to Italian parents, Pareto studied mathematics, physics, and engineering at the University of Turin in Italy.
He spent time as the director of the Italian railway, but in 1893 replaced Leon Walras (1834-1910) as the chair of political
economy at the University of Lausanne in Switzerland. Pareto is referred to as a welfare economist, meaning his analysis
focused on maximizing society's well-being.

Quiz 1
(See related pages)

1
A purely competitive seller's demand curve coincides with all of the following except:

A) its marginal revenue curve

B) its average revenue curve

C) the market price

D) the industry demand curve

2
Firms in purely competitive markets:

A) have unit elastic demand curves

B) are "price takers"

C) engage in significant advertising

D) face significant barriers to entry

3
Compared to the downward-sloping demand curve for the output of a competitive industry, a single firm
operating in that industry faces:

A) a perfectly inelastic demand curve

B) a perfectly elastic demand curve

C) a unit elastic demand curve

D) a downward-sloping marginal revenue curve

4
Use the following diagrams to answer the next question.

Refer to the diagrams. Suppose the market price is G, which is the basis for the total revenue curve in the
panel on the left. Which output level in the right panel corresponds to an output level of 320 in the left
panel?

A) A

B) B

C) C

D) D

5
Which of the following is a characteristic of equilibrium in long-run competitive markets?

A) Consumer surplus is minimized

B) Producer surplus exceeds consumer surplus

C) Total consumer and producer surplus is maximized

D) The difference between producer surplus and consumer surplus is maximized

6
Answer the next question on the basis of the following diagram:
 Refer to the diagram. This competitive firm's supply curve connects points:

A) E and H

B) G, K, and L

C) M, J, and L

D) M, N, and K

7
The market for which of the following most closely approximates pure competition?

A) feed corn

B) breakfast cereal

C) MP3 players

D) computers

8
The economic profits of firms in long-run competitive equilibrium are:

A) zero if it is a constant cost industry, positive otherwise

B) negative

C) positive

D) zero

9
Use the following data to answer the next question.

Refer to the table. Suppose the firm's goal is maximum profits (or minimum losses.) If this firm's minimum
average variable cost is $23, the firm will produce:

A) 0 units

B) 2 units

C) 3 units
 D) 4 units

10
An industry comprised of many firms, each of which is engaged in substantial nonprice competition is an
example of:

A) pure competition

B) monopolistic competition

C) oligopoly

D) pure monopoly
Quiz 2
(See related pages)

1
Economic profit per unit is equal to:

A) P - ATC

B) AR - AVC

C) MR - MC

D) P - MC

2
Economists assume that firms seek to maximize:

A) accounting profit

B) economic profit

C) economic profit per unit

D) total revenue minus explicit costs

3
Use the following data from a purely competitive industry to answer the next question.

Refer to the data. At the equilibrium price, each of the 1,000 identical firms in this industry will produce:

A) 85 units of output

B) 850 units of output

C) 800 units of output

D) 8000 units of output

4
Use the following diagram to answer the next question.

At which of the following prices will the firm produce a positive amount but incur a loss?

A) P1

B) P2

C) P3

D) P3 and P4

5
Answer the next question on the basis of the following cost data for a competitive firm.

Refer to the above data. If the market price is $35 and the firm produces its optimal amount, it will:

A) realize a $5 profit

B) realize a $50 profit

C) incur a $5 loss

D) incur a $55 loss

6
Pure competition is characterized by all of the following except:

A) a downward-sloping market demand curve

B) a perfectly elastic demand curve facing each firm

C) equality of marginal revenue and price for each firm in a given market

D) positive long-run economic profits

7
Use the following diagram to answer the next question.
 Refer to the above diagrams, which pertain to a purely competitive firm and the industry in which it
operates. True or false: The firm will produce q units and incur an economic loss.

A) True

B) False

8
Assume the ZYX Corporation is producing 50 units of output and selling it in a competitive market for $3 per
unit. Its average fixed cost is $1 and its average variable cost is $2.50; marginal cost is $2.75. In the short
run, this corporation:

A) should shut down

B) should expand production

C) should produce less (but still a positive amount)

D) is maximizing profit

9
Competitive firms maximize:

A) total profits by producing where price exceeds average total cost by the greatest amount

B) per unit profits by producing where marginal revenue equals marginal cost

C) total profits by producing where price equals marginal cost

D) market share by producing where price equals average total cost

10
Suppose a decrease in product demand occurs in a decreasing-cost industry. Compared to the original
equilibrium the new long-run competitive equilibrium will entail:

A) a higher price and a higher total output

B) a lower price and a lower total output

C) a higher price and a lower total output

D) a lower price and a higher total output

Quiz 3
(See related pages)

1
Price-taking behavior is a feature of:

A) pure competition
 B) monopolistic competition

C) oligopoly

D) monopoly

2
Oscar is one of many farmers growing soybeans in the upper Midwest under purely competitive market
conditions. As Oscar perceives it, the demand curve for Oscar's soybeans:

A) is downward sloping

B) is perfectly inelastic

C) coincides with Oscar's marginal revenue curve

D) lies above his marginal revenue curve

3
Use the following data to answer the next question.

Refer to the table. Suppose the firm's goal is maximum profits (or minimum losses.) If this firm's minimum
average variable cost is $23, the firm will produce:

A) 0 units

B) 2 units

C) 3 units

D) 4 units

4
Answer the next question on the basis of the following cost data for a competitive firm.

Refer to the above data. If the market price is $50 and the firm produces its optimal amount, it will:

A) realize a $15 profit

B) realize a $80 profit

C) realize a $90 profit

D) incur a $15 loss

5
A competitive firm is currently producing 2000 units per month at a total cost of $12,000. Its fixed costs are
$1,000 and its marginal cost is $5. If the market price is $5.60, this firm:

A) should shut down

B) should increase production

C) is making an economic profit, but not an accounting profit

D) is maximizing profits

6
A purely competitive firm's output is currently such that its marginal cost is $225 and rising. Its marginal
revenue is $210. Assuming profit maximization, this firm should:

A) cut its price and increase production

B) raise its price and cut production

C) cut its price and cut production

D) leave price unchanged and cut production

7
For all values above minimum average variable cost, a competitive firm's:

A) supply curve is coincident with its marginal cost curve

B) supply curve is coincident with its average total cost curve

C) demand curve is coincident with its average total cost curve

D) demand curve is coincident with its supply curve

8
Use the following diagrams to answer the next question.

Refer to the above diagrams, which pertain to a purely competitive firm and the industry in which it
operates. In the long run we should expect:

A) new firms to enter, market demand to rise, and price to fall

B) demand to increase, and price to rise

C) input prices to fall, supply to increase, and price to fall

D) exit of some firms, supply to decrease, and price to rise

9
Use the following diagram to answer the next question.
 Which one of the following price-quantity combinations is not on this competitive firm's short-run supply
curve?

A) P1, 47

B) P2, 44

C) P3, 40

D) P4, 30

10
In the long run, competitive markets achieve:

A) allocative efficiency because P = min ATC but not productive efficiency because P > min AVC

B) allocative efficiency because P = MC and productive efficiency because P = min ATC

C) productive efficiency because P = min ATC but not allocative efficiency because P > MR

D) neither productive nor allocative efficiency