Practice Questions: 5 Coverage: Perfect Competition I. 1.

Multiple Choice Questions: The perfectly competitive firms short run supply curve is the upward-sloping part of its a. Average variable cost curve, at all points above the point of AVCmin. b. Marginal cost curve, at all points above the point of AFCmin. c. Marginal revenue curve, at all points above the point of minimum average revenue. d. Marginal revenue curve, at all points above the point of minimum average total cost. e. Marginal cost curve, at all point above the point of AVCmin. A perfectly competitive firm will produce output in the short run even if P<ATC because a. As long as P MC, it can minimize it losses. b. As long as P AVCmin, it can minimize it losses. c. Profits are positive. d. Fixed costs are avoidable in the short run. e. None of the above. The supply curve for an individual firm in a perfectly competitive industry is P=1+2Qs. If the industry consists of 100 identical firms, what is the industry supply when P=$7? a. 300 units. b. 400 units. c. 600 units. d. 800 units. e. None of the above. In the short run, a perfectly competitive firms break-even point (P=ATC) occurs at a. A greater quantity of output than the shutdown point. b. A smaller quantity than the shutdown point. c. The same quantity as the shutdown point. d. A lower price than the shutdown point. e. The same price as the shutdown point. A perfectly competitive firm is maximizing profit if a. Marginal cost equals price and price is above minimum AVC. b. Marginal cost equals price and price is above minimum AFC. c. Total revenue is at a maximum. d. AVC is at a minimum. e. ATC is at a minimum. If a profit-maximizing firm's marginal revenue is greater than its marginal cost, the firm a. must be making an economic profit. b. will decrease its output. c. will increase its output. d. must be experiencing economic losses. e. will close down.

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Part II: Short Questions 1. The table on the right sets out the market demand schedule for tapes, and the table on the left shows the cost structure of a perfectly competitive firm. There are 1,000 firms in the industry. Price 3.65 4.40 5.20 6.0 7.6 8.4 9.2 10 10.8 11.6 12.4 13.2 14 14.8 Quantity Demanded 500,000 475,000 450,000 425,000 375,000 350,000 325,000 300,000 275,000 250,000 225,000 200,000 175,000 150,000 Output 150 200 250 300 350 400 450 500 MC 6 6.4 7 7.65 8.4 10 12.4 12.7 AVC 8.8 7.8 7 7.1 7.2 7.5 8 9 ATC 15.47 12.8 11 10.43 10.06 10 10.22 11

(i) What is the market price? Answer: To find Qd=Qs, find P=MC. There are 4 pairs in which P=MC: 6, 8.4, 10, 12.4. But the market price has to be at least $7 (AVCmin) in order for the firm to supply any Q, so the pair P=MC=6 is out. Now we have to find the pair that gives us Qd=Qs. The answer is P=MC=8.4. Note: there are 1,000 firms in the industry. (ii) (iii) (iv) (v) (vi) What is the industrys output? Answer: Straight from above, Qs=Qd=350,000. What is the output of each firm? Answer: Also straight from above, qs for each firm is 350. What is the economic profit of each firm? Answer: =(8.4-10.06)qs<0, which is -$581. What is the shutdown point? Answer: P<AVCmin=7 What is the long run equilibrium price? You can assume that the above ATC applies to both short run and long run. Conceptually, in the long run, the column AVC disappears. Graphically, the amount of K in both the long run and the short run is the same. Answer: Long run =0 The next case in which P=ATC is when they are equal to $10. This is achieved by the existing firms exiting the market, decreasing industry supply, and therefore pushing the price up from $8.4 to $10, i.e., until there is no incentive left for firms to exit or enter the industry.

(vii) What is the number of firms in the industry? Answer: How many firms have exited? We know that the quantity demanded at P=$10 is 300,000 units, and each firm will supply 400 units. The number of firms in the industry is equal to 300,000/400 750. We have 250 fewer firms in the long run, compared to the short run. Since the 1,000 firms in the short run are making losses, some of them must exit in the long run.

2. Suppose the market for dot-com companies is characterized by perfect competition. The cost function TC as given below for a representative firm can be assumed to be the cost function faced by every firm in the industry. A typical firms TC = Qs2 + 10Qs + 100; Qs is individual firms quantity supplied. From the TC equation we can obtain the equation for MC. You are not required to know how to derive MC from TC, but to those students who are familiar with calculus, differentiating TC with respect to Q will give us MC. The MC equation will always be given to you in this course. A typical firms MC = 2Qs + 10; Qs is individual firms quantity supplied. Total demand from all consumers in this market is given by P = 1000 QD Notice that the total demand is faced by ALL of the firms together, not an individual firm. Each firm takes P as given, but all firms collectively determine P. In the industry equilibrium QD=QS, where QS is the sum of all individual firms Qs. (i) Individual firm: Let P be unknown for now. Draw the relevant cost curves of a typical firm and depict the supply quantity of this firm. Ans:

(ii) (iii) (iv) (v) (vi)

Individual firm: Let P be unknown for now. Solve for the individual firms Qs. Ans: Set MC=ATC, where ATC=TC/Q, this will yield Q=10. Individual firm: Let P be unknown for now. Find the individual firms MC. Ans: Plug Q=10, MC=$30. Individual firm: Let P be unknown for now. Find the individual firms ATC. Ans: ATC=MC=$30. Individual firm: Find the identical P that each firm will charge. Ans: P=MC=ATC=$30. Industry: Given your P in (v), find the industry equilibrium QS=QD. Ans: P=1000-QD, so $30=1000-QD, so QD=QS=970.

(vii) Given all of your answers above, how many firms are there in the industry? Ans: Since we know each firm supplies Q=10, and total QS=970, so there are 97 firms. (viii) What is the value of industry profits? Ans: Since P=ATC, profits=$0. (ix) Draw three diagrams side by side. Let the diagram farthest to the left be the diagram for firm 1, the diagram in the middle be the diagram for firm 2, and the diagram to the farthest right be the diagram for industry supply. Depict all the relevant cost curves, prices and quantities in all three diagrams. Ans: