8.

1 Perfectly Competitive Markets

1) A price taker is
A) a firm that accepts different prices from different customers.
B) a consumer who accepts different prices from different firms.
C) a perfectly competitive firm.
D) a firm that cannot influence the market price.
E) both C and D
Answer: E

3) Which of following is a key assumption of a perfectly competitive market?

A) Firms can influence market price.
B) Commodities have few sellers.
C) It is difficult for new sellers to enter the market.
D) Each seller has a very small share of the market.
E) none of the above
Answer: D

4) Several years ago, Alcoa was effectively the sole seller of aluminum because the firm
owned nearly all of the aluminum ore reserves in the world. This market was not perfectly
competitive because this situation violated the:
A) price-taking assumption.
B) homogeneous product assumption.
C) free entry assumption.
D) A and B are correct.
E) A and C are correct.
Answer: E

6) Firms often use patent rights as a:

A) barrier to exit.
B) barrier to entry.
C) way to achieve perfect competition.
D) none of the above
Answer: B

7) A few sellers may behave as if they operate in a perfectly competitive market if the market
demand is:
A) highly inelastic.
B) very elastic.
C) unitary elastic.
D) composed of many small buyers.
Answer: B
5) The "perfect information" assumption of perfect competition includes all of the following
except one. Which one?
A) Consumers know their preferences.
B) Consumers know their income levels.
C) Consumers know the prices available.
D) Consumers can anticipate price changes.
E) Firms know their costs, prices and technology.
Answer: D

8.3 Marginal Revenue, Marginal Cost, and Profit Maximization

1) Revenue is equal to
A) price times quantity.
B) price times quantity minus total cost.
C) price times quantity minus average cost.
D) price times quantity minus marginal cost.
E) expenditure on production of output.
Answer: A

3) A firm maximizes profit by operating at the level of output where

A) average revenue equals average cost.
B) average revenue equals average variable cost.
C) total costs are minimized.
D) marginal revenue equals marginal cost.
E) marginal revenue exceeds marginal cost by the greatest amount.
Answer: D

5) When the TR and TC curves have the same slope,

A) they are the furthest from each other.
B) they are closest to each other.
C) they intersect each other.
D) profit is negative.
E) profit is zero.
Answer: A

7) If current output is less than the profit-maximizing output, which must be true?
A) Total revenue is less than total cost.
B) Average revenue is less than average cost.
C) Average revenue is greater than average cost.
D) Marginal revenue is less than marginal cost.
E) Marginal revenue is greater than marginal cost.
Answer: E

9) At the profit-maximizing level of output, marginal profit

A) is also maximized.
B) is zero.
C) is positive.
D) is increasing.
E) may be positive, negative or zero.
Answer: B

12) The perfectly competitive firm's marginal revenue curve is

A) exactly the same as the marginal cost curve.
B) downward-sloping, at twice the (negative) slope of the market demand curve.
C) vertical.
D) horizontal.
E) upward-sloping.
Answer: D

13) Because of the relationship between a perfectly competitive firm's demand curve and its
marginal revenue curve, the profit maximization condition for the firm can be written as
A) P = MR.
B) P = AVC.
C) AR = MR.
D) P = MC.
E) P = AC.
Answer: D

20) The following table contains information for a price taking competitive firm. Complete
the table and determine the profit maximizing level of output (round your answer to the
nearest whole number).

Total Marginal Fixed Average Total Average Marginal

Output Cost Cost Cost Cost Revenue Revenue Revenue
0 5 0
1 7 10
2 11 20
3 17 30
4 27 40
5 41 50
6 61 60

Answer:
Total Marginal Fixed Avg Total Average Marginal
Output Cost Cost Cost Cost Revenue Revenue Revenue
0 5 - 5 - 0 - -
1 7 2 5 7 10 10 10
2 11 4 5 5.5 20 10 10
3 17 6 5 6 30 10 10
4 27 10 5 7 40 10 10
5 41 14 5 8 50 10 10
6 61 20 5 10 60 10 10
The profit maximizing level of output is either 3 or 4. Note that at Q = 4 the profit-
maximizing condition MR = MC is satisfied. Since this problem is discrete, the profit at Q =
3 happens to be the same as the profit at Q = 4, so either of these answers is correct.

8.4 Choosing Output in the Short Run

Consider the following diagram where a perfectly competitive firm faces a price of $40.

Figure 8.1

1) Refer to Figure 8.1. The profit-maximizing output is

A) 30.
B) 54.
C) 60.
D) 67.
E) 79.
Answer: D
Diff: 1
Section: 8.4

2) Refer to Figure 8.1. The firm earns zero profit at what output?
A) 0.
B) 34 and 79.
C) 54.
D) 60.
E) 67.
Answer: B
Diff: 1
Section: 8.4
3) Refer to Figure 8.1. At 67 units of output, profit is
A) maximized and zero.
B) maximized and negative.
C) maximized and positive.
D) not maximized, and zero.
E) not maximized, and negative.
Answer: C
Diff: 1
Section: 8.4

4) Refer to Figure 8.1. At the profit-maximizing level of output, ATC is

A) $26.
B) $30.
C) $31.
D) $40.
E) $44.
Answer: C
Diff: 1
Section: 8.4

5) Refer to Figure 8.1. At the profit-maximizing level of output, AVC is

A) $22.
B) $26.
C) $30.
D) $32.
E) $40.
Answer: B
Diff: 1
Section: 8.4

6) Refer to Figure 8.1. At the profit-maximizing level of output,

A) AVC is minimized.
B) ATC is minimized.
C) MC is minimized.
D) total cost is minimized.
E) no costs are minimized.
Answer: E
Diff: 1
Section: 8.4

7) Refer to Figure 8.1. At the profit-maximizing level of output, total revenue is

A) $1200.
B) $2160.
C) $2400.
D) $2680.
E) $3160.
Answer: D
10) Bette's Breakfast, a perfectly competitive eatery, sells its "Breakfast Special" (the only
item on the menu) for $5.00. The costs of waiters, cooks, power, food etc. average out to
$3.95 per meal; the costs of the lease, insurance and other such expenses average out to $1.25
per meal. Bette should
A) close her doors immediately.
B) continue producing in the short and long run.
C) continue producing in the short run, but plan to go out of business in the long run.
D) raise her prices above the perfectly competitive level.
E) lower her output.
Answer: C

33) Conigan Box Company produces cardboard boxes that are sold in bundles of 1000 boxes.
The market is highly competitive, with boxes currently selling for $100 per thousand.
Conigan's total and marginal cost curves are:
TC = 3,000,000 + 0.001Q2
MC = 0.002Q
where Q is measured in thousand box bundles per year.
a. Calculate Conigan's profit maximizing quantity. Is the firm earning a profit?
b. Analyze Conigan's position in terms of the shutdown condition. Should Conigan operate
or shut down in the shortrun?
Answer:
a.
Given the competitive nature of the industry, Conigan should equate P to MC.
100 = 0.002Q
Q = 50,000
To determine profit:
π = TR - TC
TR = PQ
TR = $100 ∙ 50,000
TR = 5,000,000
TC = 3,000,000 + 0.001(50,000)2
TC = 3,000,000 + 2,500,000
TC = 5,500,000
π = 5,000,000 - 5,500,000
π = -500
Conigan is losing $500,000 per year.

b.
To determine if the firm should operate or shutdown, we must compare P to AVC.

AVC =
TVC = TC - TFC
TVC = 5,500,000 - 3,000,000
TVC = 2,500,000

AVC = = $50
AVC = 50;P = $100
The firm should operate since P > AVC.

8.5 The Competitive Firm's Short-Run Supply Curve

1) The supply curve for a competitive firm is

A) its entire MC curve.
B) the upward-sloping portion of its MC curve.
C) its MC curve above the minimum point of the AVC curve.
D) its MC curve above the minimum point of the ATC curve.
E) its MR curve.
Answer: C

13) The market demand for a type of carpet known as KP-7 has been estimated as:
P = 40 - 0.25Q,
where P is price ($/yard) and Q is rate of sales (hundreds of yards per month). The market
supply is expressed as:
P = 5.0 + 0.05Q.
A typical firm in this market has a total cost function given as:
C = 100 - 20.0q + 2.0q2.
a. Determine the equilibrium market output rate and price.
b. Determine the output rate for a typical firm.
c. Determine the rate of profit (or loss) earned by the typical firm.
Answer:
a.
Equate supply to demand to get Q.
40 - 0.25Q = 5.0 + 0.05Q
0.30Q = 35
Q = 116.7 (hundreds of yards per month)
P = 40 - 0.25(116.7) = $10.825 / yard

b.
The typical firm produces where MC equals P.
MC = -20 + 4q
10.825 = -20 + 4q
q = 7.71 (hundreds of yards per month)

c.
The profit rate is as follows:
R(Q) = PQ = (10.825)(7.71) = 83.461
TC = 100 - 20(7.71) + 2(7.71)2 = 64.69
Profit = $18.77 (hundreds / month)

14) A competitive market is made up of 100 identical firms. Each firm has a short-run
marginal cost function as follows:
MC = 5 + 0.5Q,
where Q represents units of output per unit of time. The firm's average variable cost curve
intersects the marginal cost at a vertical distance of 10 above the horizontal axis. Determine
the market short-run supply curve. Calculate the price that would make 2,000 units
forthcoming per time period. Note the minimum price at which any quantity would be placed
on the market.
Answer: The market supply curve is the horizontal summation of the individual firms' MC
curves above the intersection with the respective average variable cost curves. We must
express the quantity in terms of MC or:
Q = 2MC - 10.
Now add the 100 short-run supply curves together:
Q1 = 2MC - 10
Q2 = 2MC - 10
. . .
. . .
. . .
Q100 = 2MC - 10

= 200MC - 1000

Now, solve for MC

MC =
MC = 0.005ΣQ + 5 (above MC = 10)
At ΣQ = 2000, the price would be
P = MC = 0.005(2000) + 5 = $15 per unit.

The lowest point on the supply curve would be just above the intersection with the average
variable cost curve (at 10 units above the horizontal axis).

17) Assume the market for tortillas is perfectly competitive. The market supply and demand
curves for tortillas are given as follows:
supply curve:
P = .000002Q demand curve: P = 11 - .00002Q
The short run marginal cost curve for a typical tortilla factory is:
MC = .1 + .0009Q

a. Determine the equilibrium price for tortillas.

b. Determine the profit maximizing short run equilibrium level of output for a tortilla
factory.
c. At the level of output determined above, is the factory making a profit, breaking-even, or
making a loss? Explain your answer.
d. Assuming that all of the tortilla factories are identical, how many tortilla factories are
producing tortillas?

Answer:
a.
The equilibrium price is the price at which the quantity supplied equals the quantity
demanded. Therefore,
.000002Q = 11 - .00002Q
Q = 500,000
P=1

b.
The profit maximizing short run equilibrium level of output for a tortilla factory is found
where marginal revenue equals marginal cost. For a perfectly competitive firm, marginal
revenue equals price. Therefore,
P = MC
1 = .1 + .0009Q
Q = 1,000

c.
Given the information provided, it cannot be determined whether the firm is making a profit
or a loss, because total cost cannot be determined from marginal cost.

d.
Since Q = 500,000 and Q = 1,000, there must be 500 firms.

14) In long-run competitive equilibrium, a firm that owns factors of production will have an
A) economic profit = $0 and accounting profit > $0.
B) economic profit > $0 and accounting profit = $0.
C) economic and accounting profit = $0.
D) economic and accounting profit > $0.
E) economic and accounting profit can take any value.
Answer: A

15) What happens in a perfectly competitive industry when economic profit is greater than
zero?
A) Existing firms may get larger.
B) New firms may enter the industry.
C) Firms may move along their LRAC curves to new outputs.
D) There may be pressure on prices to fall.
E) All of the above may occur.
Answer: E

19) The authors explain that a firm earning a zero economic profit in the long run has earned
a competitive return on their investment. What do they mean by "competitive" return in this
context?
A) The firm's return could only be earned under perfect competition and would be smaller
under imperfect competition.
B) The firm's return is at least as larger as the returns earned by other firms.
C) The firm's return is at least as larger as could be earned in another investment.
D) The firm's return is negative, which initiates stronger competition among firms in the
market.
Answer: C