Microeconomics, 7e (Perloff)

Chapter 8 Competitive Firms and Markets

8.1 Perfect Competition

1) Economists define a market to be competitive when the firms

A) spend large amounts of money on advertising to lure customers away from the
competition.
B) watch each other's behavior closely.
C) are price takers.
D) All of the above.
Answer: C
Section: Competition
Question Status: Old
AACSB: Analytic thinking

2) A market's structure is described by

A) the number of firms in the market.
B) the ease with which firms can enter and exit the market.
C) the ability of firms to differentiate their product.
D) All of the above.
Answer: D
Section: Competition
Question Status: Old
AACSB: Analytic thinking

3) Firms that exhibit price-taking behavior

A) wait for other firms to set price, take it as given, and charge a higher price.
B) have outputs that are too small to influence market price and thus take it as given.
C) take pricing behavior in their own hands.
D) are independently capable of setting price.
Answer: B
Section: Competition
Question Status: Old
AACSB: Analytic thinking

4) If consumers view the output of any firm in a market to be identical to the output of any
other firm in the market, the demand curve for the output of any given firm
A) will be identical to the market demand curve.
B) will be horizontal.
C) will be vertical.
D) cannot be determined from the information given.
Answer: B
Section: Competition
Question Status: Old
AACSB: Analytic thinking

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5) A horizontal demand curve for a firm implies that
A) the firm is a monopoly.
B) the market the firm is operating in is not competitive.
C) the firm is selling in a competitive market.
D) the products of that firm are very different from other firms' products.
Answer: C
Section: Competition
Question Status: Old
AACSB: Analytic thinking

6) In the absence of any government regulation on price, if a firm has no power to set price
on its own, one can safely conclude
A) the demand curve for the firm's product is horizontal.
B) there aren't many firms in the industry.
C) the market is in long-run equilibrium.
D) the firms in this industry are not profitable.
Answer: A
Section: Competition
Question Status: Old
AACSB: Analytic thinking

7) In a perfectly competitive market,

A) firms can freely enter and exit.
B) firms sell a differentiated product.
C) transaction costs are high.
D) All of the above.
Answer: A
Section: Competition
Question Status: Old
AACSB: Analytic thinking

8) If all conditions for a perfectly competitive market are met,

A) firms face sunk cost when entering the market.
B) firms' demand curves are horizontal.
C) the market demand curve is horizontal.
D) the firms' demand curves are downward-sloping.
Answer: B
Section: Competition
Question Status: Revised
AACSB: Analytic thinking

2
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9) In a competitive market, if buyers did not know all the prices charged by the many firms,
A) all firms still face horizontal demand curves.
B) firms sell a differentiated product.
C) demand curves can be downward sloping for some or all firms.
D) the number of firms will most likely decrease.
Answer: C
Section: Competition
Question Status: Old
AACSB: Analytic thinking

10) Many used car owners and used car dealers describe their different cars for sale in the
local newspapers and list their asking price. Many people shopping for a used car consider
the different choices listed in the paper. The market for used cars could be described as
A) relatively competitive.
B) perfectly competitive.
C) non-competitive.
D) having high transaction costs.
Answer: A
Section: Competition
Question Status: Old
AACSB: Analytic thinking

11) Many car owners and car dealers describe their different cars for sale in the local
newspapers and list their asking price. Many people shopping for a used car consider the
different choices listed in the paper. The absence of which condition prohibits this market
from being described as perfectly competitive?
A) Buyers and sellers know the prices.
B) Firms freely enter and exit.
C) Transaction costs are low.
D) Consumers believe all firms sell identical products.
Answer: D
Section: Competition
Question Status: Old
AACSB: Analytic thinking

12) A special license is required to operate a taxi in many cities. The number of licenses is
restricted. More drivers want licenses than are issued. This describes a non-perfectly
competitive market because
A) taxi services are very different.
B) firms cannot freely enter and exit the market.
C) transaction costs are high.
D) the government generates revenue from the licenses.
Answer: B
Section: Competition
Question Status: Old
AACSB: Analytic thinking

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13) If a firm operates in a perfectly competitive market, then it will most likely
A) advertise its product on television.
B) take the price of its product as determined by the market.
C) have a difficult time obtaining information about the market price.
D) have an easy time keeping other firms out of the market.
Answer: B
Section: Competition
Question Status: Old
AACSB: Analytic thinking

14) If a firm operates in a perfectly competitive market, then

A) all firms will advertise.
B) no firms will advertise.
C) the market leader will advertise.
D) new firms will advertise.
Answer: B
Section: Competition
Question Status: Old
AACSB: Analytic thinking

15) The "Got Milk?" advertising campaign is a good example of

A) advertising in a competitive market.
B) how advertising in a competitive market does not pay off for a single firm.
C) interest groups financed by the industry advertise for the whole industry.
D) All of the above.
Answer: D
Section: Competition
Question Status: Old
AACSB: Analytic thinking

16) The perfectly competitive model makes a lot of fairly unrealistic assumptions. Why do
economics text books still talk a lot about this model?
A) Many markets are close to being perfectly competitive.
B) It is an important model to use as a benchmark to compare other markets structures to.
C) Perfectly competitive markets maximize societal welfare.
D) All of the above.
Answer: D
Section: Competition
Question Status: Old
AACSB: Analytic thinking

4
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17) If a firm happened to be the only seller of a particular product, it might behave as a
price taker as long as
A) buyers have full information about the firm's price.
B) the transaction costs of doing business with this firm are low.
C) there are many buyers.
D) there is free entry and exit.
Answer: D
Section: Competition
Question Status: Old
AACSB: Analytic thinking

18) The demand curve that an individual competitive firm faces is known as its
A) excess demand curve.
B) market demand curve.
C) residual demand curve.
D) leftover demand curve.
Answer: C
Section: Competition
Question Status: Revised
AACSB: Analytic thinking

19) Even if two products have different characteristics, such as color, the products are only
considered heterogeneous if consumers
A) consider the two products as perfect complements.
B) consider the two products as perfect substitutes.
C) consider the two products as imperfect substitutes.
D) consider the two products as imperfect complements.
Answer: C
Section: Competition
Question Status: Old
AACSB: Analytic thinking

20) Which of the following are not characteristics of a competitive market?

A) There is freedom of entry and exit.
B) There are zero transaction costs.
C) There are only one or two sellers.
D) Buyers and sellers have complete information.
Answer: C
Section: Competition
Question Status: Old
AACSB: Analytic thinking

5
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21) Which of the following characteristics of a competitive market make auction sites such
as eBay so popular?
A) There is freedom of entry and exit.
B) There are very low transaction costs.
C) There are only one or two sellers.
D) Buyers and sellers have complete information.
Answer: B
Section: Competition
Question Status: Old
AACSB: Analytic thinking

22) Many auction sites, such as eBay, provide a reputation score by which previous
customers can rate a seller. Which of the following characteristics of a competitive market
is this policy trying to emulate?
A) There is freedom of entry and exit.
B) There are very low transaction costs.
C) There are only one or two sellers.
D) Buyers have more complete information.
Answer: D
Section: Competition
Question Status: Old
AACSB: Analytic thinking

23) In a competitive market, one would expect to see

A) no advertising.
B) false advertising.
C) advertising only in the Sunday papers.
D) minimal advertising.
Answer: A
Section: Competition
Question Status: Old
AACSB: Analytic thinking

24) How can the market demand for a product be inelastic but the demand for a particular
firm is elastic?
A) There is no advertising.
B) There is a sufficiently large number of sellers.
C) There is only one or two sellers.
D) Buyers do not have complete information.
Answer: B
Section: Competition
Question Status: Old
AACSB: Analytic thinking

6
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25) The model of perfect competition is valuable for
A) prediction.
B) comparison to other markets.
C) Either A or B
D) None of the above.
Answer: C
Section: Competition
Question Status: Old
AACSB: Analytic thinking

26) In a competitive market where the elasticity of the market demand curve is -0.5, there
are 100 identical firms, and the elasticity of the supply curve to the other 99 firms is 4.
What is the elasticity of the demand curve of the 100th firm?
A) -446
B) -489
C) -50
D) -0.5
Answer: A
Section: Competition
Question Status: New
AACSB: Analytic thinking

For the following, please answer "True" or "False" and explain why.

27) A market is perfectly competitive even if firms have the ability to set their own price as
long as the price difference reflects differences in the product.
Answer: False. If the market is perfectly competitive, there are no differences in the
product.
Section: Competition
Question Status: Old
AACSB: Analytic thinking

28) If transaction costs are high, then it is more likely a firm's demand curve is downward
sloping.
Answer: True. Transaction costs increase the costs for consumers to find a new firm. Thus,
high transaction costs allow a firm to charge more than others.
Section: Competition
Question Status: Old
AACSB: Analytic thinking

29) Explain why individual firms in competitive markets face more elastic demand curves
than the market as a whole.
Answer: In a competitive market, if an individual firm increases its price it will lose all of
its customers, as consumers simply buy from another firm. However, if the price of the
good increases for all firms some consumers will not continue to buy the good, but for
many prices some consumers will continue to purchase the good.
Section: Competition
Question Status: Old
AACSB: Analytic thinking

8.2 Profit Maximization

1) If a firm makes zero economic profit, then the firm

A) has no incentive to stay in the industry.
B) is better off exiting the industry.
C) is indifferent between staying and exiting the industry.
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D) will shut down.
Answer: C
Section: Profit Maximization
Question Status: Revised
AACSB: Analytic thinking

2) If a firm makes zero economic profit, then the firm

A) has total revenues greater than its economic costs.
B) must shut down.
C) can be earning positive business profit.
D) must have no fixed costs.
Answer: C
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

3) A small business owner earns $50,000 in revenue annually. The explicit annual costs
equal $30,000. The owner could work for someone else and earn $25,000 annually. The
owner's business profit is ________ and the economic profit is ________.
A) $20,000, $5,000
B) $20,000, -$5,000
C) $25,000, -$5,000
D) $45,000, -$5,000
Answer: B
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

4) A small business owner earns $60,000 in revenue annually. The explicit annual costs
equal $40,000. The owner could work for someone else and earn $25,000 annually. The
owner's accounting profit is ________ and owner's economic profit is ________.
A) $20,000, $5,000
B) $20,000, -$5,000
C) $25,000, -$5,000
D) $45,000, -$5,000
Answer: B
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

8
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5) If a competitive firm's marginal profit is positive at an output of 1000 units,
A) at 1000 units, MR = MC.
B) it should produce more than 1000 units.
C) it should produce less than 1000 units.
D) at 1000 units, MR < MC.
Answer: B
Section: Profit Maximization
Question Status: New
AACSB: Analytic thinking

6) If marginal revenue equals marginal cost, the firm is maximizing profits as long as
A) the resulting profits are positive.
B) marginal cost exceeds marginal revenue for greater levels of output.
C) the average cost curve lies above the demand curve.
D) All of the above are required.
Answer: B
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

7) If a firm is operating at an output level where losses are minimized, the firm
A) has no incentive to stay in the industry.
B) is better off exiting the industry.
C) is maximizing profits.
D) will shut down.
Answer: C
Section: Profit Maximization
Question Status: Revised
AACSB: Analytic thinking

9
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8) The above figure shows the cost curves for a competitive firm. If the firm is to earn
economic profit, price must exceed
A) $0.
B) $5.
C) $10.
D) $11.
Answer: C
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

9) The above figure shows the cost curves for a competitive firm. The firm will incur
economic losses if the price is less than
A) $0.
B) $5.
C) $10.
D) $11.
Answer: C
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

10
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10) The above figure shows the cost curves for a competitive firm. If the market price is
$15 per unit, the firm will earn profits of
A) $0.
B) $4.
C) $40.
D) $160.
Answer: D
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

11) If a competitive firm maximizes short-run profits by producing some quantity of output,
which of the following must be true at that level of output?
A) p = MC
B) MR = MC
C) p ≥ AVC
D) All of the above
Answer: D
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

12) If a competitive firm maximizes short-run profits by producing some quantity of output,
which of the following must be true at that level of output?
A) p > MC
B) MR > MC
C) p ≥ AVC
D) All of the above
Answer: C
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

13) If a profit-maximizing firm finds that, at its current level of production, MR > MC, it will
A) earn greater profits than if MR = MC.
B) increase output.
C) decrease output.
D) shut down.
Answer: B
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

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14) If a profit-maximizing firm finds that, at its current level of production, MR < MC, it will
A) decrease output.
B) increase output.
C) shut down.
D) operate at a loss.
Answer: A
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

15) If a firm traded on the New York Stock Exchange posts an accounting profit of $10
million, then the firm is making a positive economic profit
A) only if the Securities and Exchange Commission (SEC) approves the accounting report.
B) only if the firm's opportunity cost is less than $10 million.
C) only if the firm's opportunity benefit is more than $10 million.
D) only if the firm's management receives stock compensation.
Answer: B
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

16) If a firm goes out of business because of negative economic profits, its books
A) might indicate a positive accounting profit.
B) might indicate that opportunity costs were zero.
C) might indicate that taxes are too high.
D) might suggest a mistaken value of explicit costs.
Answer: A
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

For the following, please answer "True" or "False" and explain why.

17) Even though fixed costs do not affect the output decision, an increase in fixed costs
results in a wider range of prices for which the firm operates at a loss.
Answer: True. An increase in fixed costs will shift AC upward but leave AVC unchanged.
The gap between AVC and AC represents prices at which the firm will operate at a loss.
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

12
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18) If a firm sets marginal revenue equal to marginal cost, it will make an economic profit.
Answer: False. When a firm sets MR=MC it maximizes profits but the profit-maximizing
level of output might still be negative (the smallest loss possible).
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

19) If a firm doesn't make an economic profit, it will shut down.

Answer: False. The firm compares its losses from operating with its losses when shutting
down and will shut down if the latter loss is less.
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

20) Suppose there are 20 competitive firms in a market. The supply curve of each firm is q
= 2p. The market demand is Q = 200 - 2p. What is the residual demand curve facing a
typical firm?
Answer: The residual demand curve is equal to the market demand curve minus the supply
of all the other firms. The supply of the other 19 firms is 38p. The residual demand is 200 -
40p.
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

21) Explain why shutting down and going out-of-business are different concepts.
Answer: Shutting down means that the firm seizes production with the option of starting
up production any time in the future. Going out-of-business is equal to exiting the industry.
This involves reducing the amount of (the fixed input) capital to zero, which is not possible
in the short run.
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

22) Suppose a firm has the following total cost function: TC = 100 + 4q2. What is the
minimum price necessary for the firm to earn profit? Below what price will the firm shut
down in the short run?
Answer: AC = 100/q + 4q. This is minimized when dAC/dq = 0, or -100/q2 + 4 = 0. Solving
yields q = 5 and AC = 40. Thus, a price greater than $40 is required for the firm to earn
profit. AVC = 4q and MC = 8q. Since AVC is below MC for all levels of output, AVC will be
less than price for all levels of output. The firm will not shut down in the short run.
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

13
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23) The above figure shows the cost curves for a typical firm in a competitive market. Note
that if p = 10, then MC = p at both q = 5 and q = 60. Can they both yield maximum profit?
Explain.
Answer: No, at q = 5, p = MC, but this is not profit maximization; it is profit minimization.
Profits expand as output increases since MR > MC for higher levels of output. At q = 60, an
increase or decrease in output causes profits to fall, so this is the profit-maximizing q.
Thus, one way of wording the "second order condition" for profit maximization is that MC
must cut the demand curve from below.
Section: Profit Maximization
Question Status: Old
AACSB: Analytic thinking

8.3 Competition in the Short Run

1) A firm should always shut down if its revenue is

A) declining.
B) less than its average fixed costs.
C) less than its total costs.
D) less than its avoidable costs.
Answer: D
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

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2) Suppose a competitive firm's total revenue is $1,000,000 where MR = MC, its explicit
variable costs are $900,000, its fixed costs are $90,000 of which $60,000 are sunk in the
short run.. If its implicit opportunity costs are $50,000, the firm should
A) produce because its economic profit is positive.
B) produce because its economic profit is zero.
C) produce even though its economic profit is negative.
D) shut down.
Answer: C
Section: Competition in the Short Run
Question Status: New
AACSB: Analytic thinking

3) If a competitive firm finds that it maximizes short-run profits by shutting down, which of
the following must be true?
A) p < AVC for all levels of output.
B) p < AVC only for the level of output at which p = MC.
C) p < AVC only if the firm has no fixed costs.
D) The firm will earn zero profit.
Answer: A
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

4) In a graph of a firm's short-run total costs and total revenue, the total cost and the total
revenue curves, respectively, will intersect the vertical axis
A) above the origin, above the origin.
B) above the origin, at the origin.
C) at the origin, at the origin.
D) below the origin, below the origin.
Answer: B
Section: Competition in the Short Run
Question Status: New
AACSB: Analytic thinking

5) The above figure shows the cost curves for a competitive firm. If the firm is to operate in
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the short run, price must exceed
A) $0.
B) $5.
C) $10.
D) $11.
Answer: B
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

6) The above figure shows the cost curves for a competitive firm. If the profit-maximizing
level of output is 40, price is equal to
A) $0.
B) $15.
C) $10.
D) $11.
Answer: B
Section: Competition in the Short Run
Question Status: Revised
AACSB: Analytic thinking

16
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7) A firm will shut down in the short run if
A) total fixed costs are too high.
B) total revenue from operating would not cover all costs.
C) total revenue from operating would not cover variable costs.
D) total revenue from operating would not cover fixed costs.
Answer: C
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

8) The reasons why a competitive firm's short-run supply curve is upward sloping are
A) the law of diminishing marginal returns and profit maximization.
B) constant returns to scale and profit maximization.
C) decreasing returns to scale and profit maximization.
D) Both B and C.
Answer: A
Section: Competition in the Short Run
Question Status: New
AACSB: Analytic thinking

9) The competitive firm's supply curve is equal to

A) its marginal cost curve.
B) the portion of its marginal cost curve that lies above AC.
C) the portion of its marginal cost curve that lies above AVC.
D) the portion of its marginal cost curve that lies above AFC.
Answer: C
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

10) If a firm is a price taker, then its marginal revenue will always equal
A) price.
B) total cost.
C) zero.
D) one.
Answer: A
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

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11) An increase in the cost of an input will result in
A) a leftward shift in the firm's supply curve.
B) an upward shift of the firm's marginal cost curve.
C) a leftward shift of the market supply curve.
D) All of the above.
Answer: D
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

12) When the production of a good involves several inputs, an increase in the cost of one
input will usually cause total costs to
A) rise more than in proportion.
B) rise less than in proportion.
C) remain unchanged.
D) rise by the exact amount of the input price increase.
Answer: B
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

13) When the production of a good involves several inputs and inputs are used in fixed
proportions, an increase in the cost of one input will usually cause total costs to
A) rise more than in proportion.
B) rise less than in proportion.
C) remain unchanged.
D) rise by the exact amount of the input price increase.
Answer: D
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

14) If a competitive firm is in short-run equilibrium, then

A) profits equal zero.
B) it will not operate at a loss.
C) an increase in its fixed cost will have no effect on profit.
D) an increase in its fixed cost will have no effect on output.
Answer: D
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

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15) If a competitive firm is in short-run equilibrium, then
A) economic profits equal zero.
B) economic profits will be positive.
C) economic profits will be negative.
D) All of the above are possible in the short-run.
Answer: D
Section: Competition in the Short Run
Question Status: Revised
AACSB: Analytic thinking

16) Suppose a firm's costs are F + v ∗ q2 where F and v are positive real numbers and the
firm sells its product at the market determined price p. Profits are calculated using
A) p ∗ q - F - v ∗ q2.
B) [p -(F/q + v ∗ q)] ∗ q.
C) [(p ∗ q)/q -(F + v ∗ q)/q] ∗ q.
D) Both A and B.
Answer: D
Section: Competition in the Short Run
Question Status: New
AACSB: Analytic thinking

17) Suppose TC = 10 + (0.1 ∗ q2). If p = 10, the firm's profit maximizing level of output is
A) 40.
B) 50.
C) 60.
D) 0, since the firm will shut down.
Answer: B
Section: Competition in the Short Run
Question Status: New
AACSB: Analytic thinking

18) Suppose TC = 10 + (0.1 ∗ q2). If p = 10, the firm's profits will be

A) 240.
B) 250.
C) 260.
D) -10 because the firm will shut down.
Answer: A
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

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19) Suppose TC = 10 + (0.1 ∗ q2). If there are 100 identical firms in the market, the

A) Q = 1000 ∗ p.
market supply curve is

B) Q = 500 ∗ p.
C) Q = 100 ∗ p.
D) Q = 10.
Answer: B
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

20) The above figure shows the cost curves for a typical firm in a market and three possible
market supply curves. If there are 100 identical firms, the market supply curve is best
represented by
A) curve A.
B) curve B.
C) curve C.
D) either curve A or B, but definitely not C.
Answer: C
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

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21) If a firm is currently in short-run equilibrium earning a profit, what impact will a lump-
sum tax have on its production decision?
A) The firm will decrease output to earn a higher profit.
B) The firm will increase output but earn a lower profit.
C) The firm will not change output but earn a lower profit.
D) The firm will not change output and earn a higher profit.
Answer: C
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

22) Suppose that once a well is dug, water flows out of it continuously without any
additional effort. Customers collect their water and pay a per gallon fee when they leave
the site of the well. In the short run, the competitive firm in this market
A) will not shut down because variable costs are zero.
B) has no fixed costs.
C) faces diminishing marginal returns.
D) can act as a price setter.
Answer: A
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

23) Suppose that once a well is dug, water flows out of it continuously without any
additional effort. Customers collect their water and pay a per gallon fee when they leave
the site of the well. In the short run, the competitive firm in this market
A) has no variable costs.
B) has no fixed costs.
C) will shut down.
D) can produce water at no cost.
Answer: A
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

24) If a competitive firm cannot earn profit at any level of output during a given short-run
period, then which of the following is LEAST likely to occur?
A) It will shut down in the short run and wait until the price increases sufficiently.
B) It will exit the industry in the long run.
C) It will operate at a loss in the short run.
D) It will minimize its loss by decreasing output so that price exceeds marginal cost.
Answer: D
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

21
Copyright © 2015 Pearson Education, Inc.
25) In deciding whether to operate in the short run, the firm must be concerned with the
relationship between price of the output and
A) total cost.
B) average variable cost.
C) total fixed cost.
D) the number of buyers.
Answer: B
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

26) There are currently N identical firms in a market. If it is a perfectly competitive market,
the short-run market supply curve at any given price is
A) N times the supply of an individual firm.
B) N - 1 times the supply of an individual firm.
C) N plus the supply of an individual firm.
D) It cannot be determined from the information provided.
Answer: A
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

27) Suppose there are two perfectly competitive industries with similar numbers of firms
but where one industry consists of N identical firms while the second consists of N firms
with differing costs. Compared to the short-run supply curve of the industry with identical
firms, the short-run supply curve of the differing cost industry will tend to be
A) steeper at higher prices.
B) flatter at higher prices.
C) steeper at lower prices.
D) flatter at lower prices.
Answer: C
Section: Competition in the Short Run
Question Status: New
AACSB: Analytic thinking

For the following, please answer "True" or "False" and explain why.

28) If a firm cannot earn profits in the short run, it will shut down.
Answer: False. A firm will operate at a loss if the loss incurred from production is less than
the loss incurred from shutting down. Even if the firm shuts down, it still must pay its fixed
costs because, in the short-run, going out of business is not an option.
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

22
Copyright © 2015 Pearson Education, Inc.
29) If the market price in a competitive market is below the minimum of average variable
cost, the firm will shut down.
Answer: True. At this price total fixed costs are smaller than the operating loss. It pays for
the firm to shut down.
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

30) If a competitive firm has to pay a lump sum tax, it will produce less.
Answer: False. A lump sum tax is not related to the amount of output produced. It will
increase fixed cost and thus lower profit. However, marginal cost will not be affected and
the profit-maximizing quantity will stay the same.
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

31) A competitive firm's supply curve is identical to its marginal cost curve.
Answer: False. The statement is only partly correct. The supply curve is only that portion
that lies above AVC.
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

23
Copyright © 2015 Pearson Education, Inc.
32) The above figure shows the cost curves for a typical firm in a competitive market. From
the graph, estimate the firm's profits when price equals $10 per unit.
Answer:
When price = 10, p = MC when q = 60. TR = 600. The AC is just above 8.5, say 8.6. This
yields TC = 516. The firm's profit is estimated to be around $84.
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

33) The above figure shows the cost curves for a typical firm in a competitive market. If
there are 200 identical firms, estimate the market quantity supplied when p = 4, 8, and 10.
Answer:
When p = 4, p < AVC so no firms will produce. At p = 8, each firm produces 50 units at a
loss. At p = 10, each firm produces 60 units. The market quantity supplied at each price is:

Section: Competition in the Short Run

Question Status: Old
AACSB: Analytic thinking

24
Copyright © 2015 Pearson Education, Inc.
34) If a firm operates at a loss, the loss is equal to TC - TR. If the firm shuts down instead,
its loss is equal to FC. Given this, show that price must exceed AVC for the firm to operate
at a loss and not shut down.
Answer: The firm operates at a loss if TC - TR < FC. Adding TR - FC to both sides yields VC
< TR. Dividing by q yields AVC < p. That is, the firm will operate at a loss as long as AVC <
p.
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

35) Suppose a firm has the following total cost function TC = 100 + 2q2. If price equals

Answer: MC = 4q. To maximize profit, set 20 = 4q, or q = 5. Profit = TR - TC = (20 ∗ 5) -

$20, what is the firm's output decision? What are its short-run profits?

(100 + 50) = -50. Since FC = 100, the firm will produce 5 units and operate at a loss of 50
rather than shutting down and incurring a loss of 100.
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

36) Draw a graph that shows how the short-run shutdown price changes when an input
price increases.
Answer:

See the above figure.

Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

25
Copyright © 2015 Pearson Education, Inc.
37) Suppose there are 1000 identical wheat farmers. For each, TC = 10 + q2 Derive the
market supply curve.
Answer:
For each MC = 2q and AVC = q. Thus MC > AVC for all levels of output. The firm sets p =
2q or q = 0.5p. Since there are 1000 firms each producing q, market supply equals Q =
500p.
Section: Competition in the Short Run
Question Status: Old
AACSB: Analytic thinking

38) Suppose there are 1000 identical wheat farmers. For each, TC = 10 + q2. Market
demand is
Q = 600,000 – 100p. Derive the short-run equilibrium Q, q, and p. Does the typical firm
earn a short-run profit?
Answer: The firm's supply is q = 0.5p; market supply is Q = 500p. Market equilibrium can
be found as 500p = 600,000 – 100p, or 600p = 600,000, so p = 1,000 and Q = 500,000. q =

Profit = (500 ∗ 1,000) - (10 + 250,000) = 249,990. Each firm earns a profit.
0.5p = 500.

Section: Competition in the Short Run

Question Status: Old
AACSB: Analytic thinking

8.4 Competition in the Long Run

1) Markets with hit-and-run entry and exit experience

A) barriers to entry.
B) firms entering whenever they can make a profit and exiting when they cannot make a
profit.
C) steady long-run economic profit.
D) a very steady number of firms.
Answer: B
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

2) In the long run, profits will equal zero in a competitive market because of
A) constant returns to scale.
B) identical products being produced by all firms.
C) the availability of information.
D) free entry and exit.
Answer: D
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

26
Copyright © 2015 Pearson Education, Inc.
3) Assuming a horizontal long-run market supply curve, which of the following statements
is (are) TRUE about competitive firms in the long run?
A) p = MC
B) p = AC
C) profit = 0
D) All of the above.
Answer: D
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

4) Long-run market supply curves are upward sloping if

A) firms are identical.
B) the number of firms is restricted in the long run.
C) input prices fall as the industry expands.
D) All of the above.
Answer: B
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

5) If the long-run supply curve in a perfectly competitive industry is upward sloping, this is
because
A) firms are different.
B) firms are identical.
C) input prices rise as the industry expands.
D) Either A or C.
Answer: D
Section: Competition in the Long Run
Question Status: New
AACSB: Analytic thinking

6) Long-run market supply curves are downward sloping if

A) firms are identical.
B) the number of firms is restricted in the long run.
C) input prices fall as the industry expands.
D) All of the above.
Answer: C
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

27
Copyright © 2015 Pearson Education, Inc.
7) If firms in a competitive market are not identical, then the long-run market supply curve
will be
A) horizontal.
B) upward sloping.
C) downward sloping.
D) undetermined.
Answer: B
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

8) If firms in a competitive market are not identical, then an increase in cost will
A) shift marginal cost to the right.
B) push the most inefficient firms out of the market.
C) push the most efficient firms out of the market.
D) Need more information.
Answer: B
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

9) Suppose that for each firm in the competitive market for potatoes, long-run average cost
is minimized at $0.20 per pound when 500 pounds are grown. If the long-run supply curve
is horizontal, then
A) some firms will enjoy long-run profits because they operate at minimum average cost.
B) the long-run price will be $0.20 per pound.
C) each consumer will purchase $100 worth of potatoes.
D) the long-run price will be set just above $0.20 per pound.
Answer: B
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

10) Suppose that for each firm in the competitive market for potatoes, long-run average
cost is minimized at $0.20 per pound when 500 pounds are grown. The demand for
potatoes is Q = 10,000/p. If the long-run supply curve is horizontal, then how many firms
will this industry sustain in the long run?
A) 0
B) 100
C) 50,000
D) There is not enough information to answer.
Answer: B
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

28
Copyright © 2015 Pearson Education, Inc.
11) Suppose that for each firm in the competitive market for potatoes, long-run average
cost is minimized at $0.20 per pound when 500 pounds are grown. The demand for
potatoes is Q = 10,000/p. If the long-run supply curve is horizontal, then how much will
consumers spend, in total, on potatoes?
A) $0
B) $500
C) $10,000
D) $50,000
Answer: C
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

12) Suppose that for each firm in the competitive market for potatoes, long-run average
cost is minimized at $0.20 per pound when 500 pounds are grown. The demand for
potatoes is Q = 10,000/p. If the long-run supply curve is horizontal, then how many pounds
of potatoes will be consumed in total?
A) 0
B) 500
C) 10,000
D) 50,000
Answer: D
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

13) Baseball teams shut down in the winter. This is an example of

A) permanently leaving the industry because price is less than average fixed cost.
B) temporarily leaving the industry because price is less than average variable cost.
C) temporarily leaving the industry because price is less than average fixed cost.
D) permanently leaving the industry because price is less than average variable cost.
Answer: B
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

14) Which is an important aspect of the perfectly competitive market that leads to long run
equilibrium?
A) perfect information
B) freedom of entry and exit
C) price taking behavior
D) homogeneous products
Answer: B
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

29
Copyright © 2015 Pearson Education, Inc.
15) Which of the following markets would reach long-run equilibrium fastest?
A) online retail
B) auto dealers
C) oil extraction
D) World Series tickets
Answer: A
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

16) Firms in long-run perfect competition produce at

A) increasing returns to scale.
B) decreasing returns to scale.
C) constant returns to scale.
D) no returns to scale.
Answer: C
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

17) Downward sloping long-run supply curves occur in markets

A) with learning-by-doing.
B) with increasing returns to scale.
C) with constant returns to scale.
D) Either A or B
Answer: D
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

18) Under what circumstances will the residual supply curve for a country be upward
sloping?
A) when it does not import any of the good from the rest of the world
B) when it imports a small portion of the rest of the world's supply of the good
C) when it imports a large portion of the rest of the world's supply of the good
D) Either A or B
Answer: C
Section: Competition in the Long Run
Question Status: New
AACSB: Analytic thinking

30
Copyright © 2015 Pearson Education, Inc.
19) Suppose the long-run supply curve for a perfectly competitive industry is horizontal at
a price of $12, and the minimum short-run average variable cost for each of the identical N
firms in the industry is $8. If the demand curve for the industry decreases so that it
intersects the short-run supply curve of the industry at $10,
A) in the short run the price will decrease to $10, and the number of firms will still be N. In
the long run the price will return to $12, and the number of firms will be less than N.
B) in the short run the price will decrease to $10, and the number of firms will be less than
N. In the long run the price will return to $12, and the number of firms will return to N.
C) in the short run the price will remain at $12, and the number of firms will still be N. In
the long run the price will fall to $8, and the number of firms will be less than N.
D) In the short run the price will decrease to $10, and the number of firms will be less than
N. In the long run the price will return to $12, and the number of firms will return to N.
Answer: A
Section: Competition in the Long Run
Question Status: New
AACSB: Analytic thinking

For the following, please answer "True" or "False" and explain why.

20) If firms in a competitive market are identical, the long-run market supply curve is
horizontal.
Answer: False. The horizontal long-run supply curve also requires that factor prices do not
increase with industry expansion and that the number of firms is not restricted.
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

21) The long-run supply curve in a competitive market is upward-sloping.

Answer: False. The shape of the long-run supply curve will depend on how similar the
firms are and on the relationship between factor prices and total industry output.
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

22) If the shutdown rule, p < AVC, is the same in the short run and the long run, explain
why the shutdown prices may be different.
Answer: In the short run there are fixed costs, but in the long run all costs are variable. In
the long run the average variable cost is usually higher than in the short run.
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

31
Copyright © 2015 Pearson Education, Inc.
23) The above figure shows the long-run cost curves for a typical firm in a competitive
market. If the number of firms is unrestricted and input costs are constant, derive the long-
run market supply curve.
Answer: The long-run market supply curve is horizontal at a price of $10 per unit.
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

24) All the supply of peppermint oil is produced from mint plants grown in one county by
several competitive growers (the number of growers is not limited). The quality of land in
the county varies greatly. Would you expect the long-run market supply curve to slope
upward, downward, or remain constant? Why?
Answer: The long-run market supply curve will slope up because the growers have
different costs. Those growers with poor-quality land have a higher average cost of
production. The horizontal sum of the individual supply curves will slope up.
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

32
Copyright © 2015 Pearson Education, Inc.
25) Suppose an industry has no fixed costs. Draw two graphs side by side for the industry.
In the left graph draw a U-shaped average cost curve and the corresponding marginal cost
curve. In the right graph, draw a downward sloping market demand curve. Also in the right
graph, draw a short-run supply curve that would generate positive profit, and the long-run
supply curve that would result in.
Answer:

See the above figure.

Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

26) Suppose all firms in a competitive market are currently in both short-run and long-run
equilibrium. What impact will a lump sum tax have on each firm in the short run? in the
long run?
Answer: In the short run, the lump sum tax represents a fixed cost. The firm's output
decision is unchanged, but its profits decrease. In the long run, the tax raises the LRAC of
each firm, but not MC. Minimum AC is higher, so price is higher. With a higher price, each
firm produces a greater quantity, but the higher price means less quantity is demanded in
total; thus, the number of firms will decrease.
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

27) Suppose market demand is Q = 1000 - 4p. If all firms have LRAC = 50 - 5q + q2, how
many identical firms will there be when this industry is in long-run equilibrium?
Answer: The long-run market supply curve is horizontal at the minimum LRAC. LRAC is
minimized when -5 + 2q = 0 or q = 2.5. At this level of output, LRMC = LRAC = 43.75. At
this price, 825 units are demanded. If each firm produces 2.5 units in the long run, then
330 firms will be in this market.
Section: Competition in the Long Run
Question Status: Old
AACSB: Analytic thinking

33
Copyright © 2015 Pearson Education, Inc.