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Chapter 14
Questions and Answers
Question 1
Refer to Table 14-1. The price and quantity
relationship in the table is most likely that faced
by a firm in a:
 a. price discriminating monopoly market.
 b. single price monopoly market.
 c. oligopoly market.
 d. monopolistically competitive market.
 e. perfectly competitive market.
Question 1 Answer
E. perfectly competitive market.
 Competitive Markets

What is a Competitive Market?

The revenue of a competitive firm
 Maximize
 Total

profit
revenue minus total cost
Total revenue = price times quantity =
PˣQ
 Proportional

Average revenue
 Total
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to the amount of output
revenue divided by the quantity sold
What is a Competitive Market?
The revenue of a competitive firm
 Marginal revenue

 Change
in total revenue from an
additional unit sold

For competitive firms
 Average
revenue = Price
 Marginal revenue = Price
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Question 2
Which of the following is NOT a characteristic
of a perfectly competitive market?
 a. Firms are price takers.
 b. Firms have difficulty entering the market.
 c. There are many sellers in the market.
 d. There are many buyers in the market.
 e. Goods offered for sale are homogeneous.
Question 2 Answer
B: Firms have difficulty entering the
market
 Competitive Markets

What is a Competitive Market?

Competitive market
 Market
with many buyers and sellers
 Trading identical products
 Each buyer and seller is a price taker
 Firms can freely enter or exit the market
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Question 3






Refer to Table 14-2.
At which quantity of
output is marginal
revenue equal to
marginal cost?
a. 2
b. 3
c. 6
d. 8
e. 9
Question 3 Answer
C: 6
 Profit Maximization

What is a Competitive Market?

Marginal revenue
 Change
in total revenue from an
additional unit sold

For competitive firms
 Average
revenue = Price
 Marginal revenue = Price
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Profit Maximization
A simple example of profit
maximization
 Maximize profit

 Produce
quantity where total revenue
minus total cost is greatest
 Compare marginal revenue (MR) with
marginal cost (MC)
MR > MC – increase production
 If MR < MC – decrease production
 If
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Question 4
If the firm finds that its marginal cost is $11, it
should
 a. increase production to maximize profit.
 b. increase the price of the product to
maximize profit.
 c. advertise to attract additional buyers to
maximize profit.
 d. reduce production to increase profit.
 e. keep production at the current level.
Question 4 Answer
D: reduce production to increase profit.
 Profit Maximization

Question 5
If the market price is P3,
in the short run, the
perfectly competitive
firm will earn:
 a. positive economic
profits.
 b. negative economic
profits but will try to
remain open.
 c. negative economic
profits and will shut
down.
 d. zero economic
profits.
 e. break-even profits.
Question 5 Answer
B: negative economic profits but will try
to remain open.
 Supply Curve

Profit Maximization& Competitive Firm’s Supply
Curve

The marginal-cost curve and the firm’s
supply decision
 Marginal
Cost (MC) curve – upward
sloping
 Average Total Cost (ATC) curve – Ushaped
 MC curve crosses the ATC curve at the
minimum of ATC curve
 Price = Average Revenue = Marginal
Revenue
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Profit Maximization& Competitive Firm’s Supply
Curve
The marginal-cost curve and the firm’s
supply decision
 Three general rules for profit
maximization:

 If
MR > MC - firm should increase output
 If MC > MR - firm should decrease output
 If MR = MC - profit-maximizing level of
output
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Profit Maximization& Competitive Firm’s Supply
Curve
The marginal-cost curve and the firm’s
supply decision
 Marginal-cost curve

 Determines
the quantity of the good the
firm is willing to supply at any price
 Is the supply curve
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Question 6
Refer to Figure 14-1. Which of the four prices
corresponds to a perfectly competitive firm
earning negative economic profits in the
short run and shutting down?
 a. P1 only
 b. P2 only
 c. P3 only
 d. P4 only
 e. P3 and P4
Question 6 Answer
D: P4 only
 Supply Curve

Question 7
Refer to Figure 14-2. When market price is P3, a
profit-maximizing firm’s total revenue
 a. can be represented by the area P3 x Q3.
 b. can be represented by the area P3 x Q2.
 c. can be represented by the area (P3-P2) x Q3.
 d. can be represented by the area (P3-P2) x Q2.
 e. is zero.
Question 7 Answer
B: can be represented by the area
P3 x Q2.
 Total Revenue

Question 8
Refer to Figure 14-2. When market price is P3, a
profit-maximizing firm’s profit
 a. can be represented by the area P3 x Q3.
 b. can be represented by the area P3 x Q2.
 c. can be represented by the area (P3-P2) x Q3.
 d. can be represented by the area P3 x Q1.
 e. is zero.
Question 8 Answer
E: is zero
 Profit

Question 9
Refer to Figure 14-2. When market price is
P3, a profit-maximizing firm’s total costs
 a. can be represented by the area P2 x Q2.
 b. can be represented by the area P3 x Q2.
 c. can be represented by the area (P3-P2) x
Q3.
 d. can be represented by the area P3 x Q3.
 e. are zero.
Question 9 Answer
B: can be represented by the area
P3 x Q2.
 Total Cost

Question 10







Output
0
1
2
3
4
5
TC
$5
$10
$12
$15
$24
$40
If the market price is $4,
this firm will
 a. produce two units in
the short run and exit
in the long run.
 b. produce three units
in the short run and
exit in the long run.
 c. produce four units in
the short run and exit
in the long run.
 d. shut down in the
short run and exit in
the long run.
 e. produce five units in
the short run and the
long run.
Question 10 Answer
B: produce three units in the short run
and exit in the long run.
 Losses

Question 11
Output
 0
 1
 2
 3
 4
 5
TC
$1
$6
$9
$10
$17
$26
What is the lowest price
at which this firm
might choose to
operate?
 a. $1
 b. $2
 c. $3
 d. $4
 e. $5
Question 11 Answer
C: $3
 Supply Curve

Profit Maximization& Competitive Firm’s Supply
Curve

Shutdown
 Short-run
decision not to produce
anything during a specific period of time
because of current market conditions
 Firm still has to pay fixed costs

Exit
 Long-run
decision to leave the market
 Firm doesn’t have to pay any costs
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Profit Maximization& Competitive Firm’s Supply
Curve

The firm’s short-run decision to shut
down
 TR
= total revenue
 VC = variable costs

Firm’s decision:
 Shut

down if TR<VC (P<AVC)
Competitive firm’s short-run supply
curve
 The
portion of its marginal-cost curve that
lies above average variable cost
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Question 12
Refer to Figure 14-3. Assume that the market starts
in equilibrium at point A in panel (b). An increase in
demand from D0 to D1 will result in:
 a. a new market equilibrium at point D.
 b. an eventual increase in the number of firms in the
market and a new long-run equilibrium at point C.
 c. rising prices and falling profits for existing firms in
the market.
 d. falling prices and falling profits for existing firms
in the market.
 e. a new long-run market equilibrium at point B.
Question 12 Answer
B: an eventual increase in the number
of firms in the market and a new longrun equilibrium at point C.
 Long-run Supply Curve

Supply Curve in a Competitive
Market

Short run: market supply with a fixed
number of firms
run – number of firms is fixed
 Each firm – supplies quantity where P =
MC
 Short
 For
P > AVC: supply curve is MC curve
 Market
 Add
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supply
up quantity supplied by each firm
Supply Curve in a Competitive
Market

Long run: market supply with entry and exit
 Long
 If
P > ATC – firms make positive profit

 If
run – firms can enter and exit the market
New firms enter the market
P < ATC – firms make negative profit

Firms exit the market
 Process


 Long
of entry and exit ends when
Firms still in market: zero economic profit (P = ATC)
Because MC = ATC: Efficient scale
run supply curve – perfectly elastic
 Horizontal
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at minimum ATC
Supply Curve in a Competitive
Market

Why do competitive firms stay in business if
they make zero profit?
= total revenue – total cost
 Total cost – includes all opportunity costs
 Zero-profit equilibrium
 Profit
 Economic
profit is zero
 Accounting profit is positive
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Supply Curve in a Competitive
Market
A shift in demand in the short run & long run
 Market – in long run equilibrium

P
= minimum ATC
 Zero economic profit

Increase in demand
curve – shifts outward
 Short run
 Demand
 Higher
quantity
 Higher price: P > ATC – positive economic profit
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Supply Curve in a Competitive
Market
A shift in demand in the short run & long run
 Because: positive economic profit in short
run
 Long run – firms enter the market

run supply curve – shifts right
 Price – decreases back to minimum ATC
 Quantity – increases
 Short
 Because
 Efficient
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there are more firms in the market
scale
Supply Curve in a Competitive
Market

Why the long-run supply curve might slope
upward
 Some
resource used in production may be
available only in limited quantities
in quantity supplied – increase in costs –
increase in price
 Increase
 Firms
may have different costs
 Some

firms earn profit even in the long run
Long-run supply curve
 More
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elastic than short-run supply curve
Profit Maximization& Competitive Firm’s Supply
Curve
 Firm’s long-run decision to exit/enter a market
 Exit
the market if
 Total
revenue < total costs; TR < TC
 Same as: P < ATC
 Enter
the market if
 Total
revenue > total costs; TR > TC
 Same as: P > ATC

Competitive firm’s long-run supply curve
 The
portion of its marginal-cost curve that lies
above average total cost
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FRQ 1

Using correctly labeled side-by-side graphs for a
market and a firm, graph a firm earning shortrun economic profits. Can this scenario be
maintained in the long run? Explain.
FRQ 1 Answer

In a competitive market where firms are
earning economic profits, new firms will
have an incentive to enter the market. This
entry will expand the number of firms,
increase the quantity of the good supplied,
and drive down prices and profits. Entry will
cease once firms are producing the output
level where price equals the minimum of the
average-total-cost curve, meaning that each
firm earns zero economic profits in the long
run.
FRQ 1 Graphs
FRQ 2

Using cost curve analysis, explain the
derivation of a perfectly competitive
firm’s short-run supply curve.
FRQ 2 Answer

A perfectly competitive firm’s short-run
supply curve is the rising portion of its
marginal cost curve above the variable cost
curve. The supply curve for a perfectly
competitive firm is represented by the
various quantities the firm would willingly put
on the market at each possible alternative
price. In the short run, a perfectly
competitive firm would operate and produce
where MC=P, as long as that occurs above
average variable cost. If the price were
below average variable cost, the firm would
shut down in the short run.