Download Chapter 13 Perfect Competition

Chapter 13
Perfect Competition
13.1 A Firm's Profit-Maximizing Choices
1) Is the number of sellers in the market the only thing that is different in each of the four
market types economists study?
Answer: No, the number of sellers is not the only factor that differs; the degree of similarity of
each firm's product also plays a role. For instance, in a perfectly competitive market,
each firm sells an identical product whereas in a monopolistically competitive
market, each firm sells a slightly different product.
Topic: Market types
Skill: Level 1: Definition
Objective: Checkpoint 13.1
Author: TS
2) Why do you never see firms in a perfectly competitive market advertise their product?
Answer: Advertising has costs and benefits for the typical firm. The cost is the expense of
running the advertising and the forgone value of the next best use of the firm's
funds. The benefit of advertising is the increased probability that the firm can
increase the demand for its good or service. Therein lies the problem for perfectly
competitive firms. Perfectly competitive firms sell an identical product. Who is going
to believe an asparagus farmer in California that runs a television ad proclaiming
that her asparagus is better than other farmers? If demand is not increased by the ad,
which is likely, the only thing that is certain is that the farmer's costs have increased.
Along with the higher costs comes decreased profit and an increased likelihood of
going out of business.
Topic: Market types
Skill: Level 5: Critical thinking
Objective: Checkpoint 13.1
Author: JC
268
Bade/Parkin œ Foundations of Economics, Third Edition
3) What are the four types of markets? Give a brief description of each type.
Answer: The four types of markets are perfect competition, monopoly, monopolistic
competition, and oligopoly.
Perfect competition has many firms selling identical products to many buyers,
œ
with no barriers to entry or exit.
Monopoly has one firm selling a good with no close substitutes and a barrier that
œ
blocks the entry of new firms.
Monopolistic competition has many firms making similar but not identical
œ
products with no barriers to entry or exit.
Oligopoly has a small number of generally large firms producing either identical
œ
or differentiated products.
Topic: Market types
Skill: Level 1: Definition
Objective: Checkpoint 13.1
Author: SB
4) What four conditions define a perfectly competitive market?
Answer: The four conditions are that:
a. many firms sell an identical product to many buyers.
b. there are no restrictions on entry into (or exit from) the market.
c. established firms have no advantage over new firms.
d. sellers and buyers are well informed about prices.
Topic: Perfect competition
Skill: Level 1: Definition
Objective: Checkpoint 13.1
Author: SA
5) "Perfectly competitive firms have total control over the price they set for their product."
Explain why the previous statement is correct or incorrect.
Answer: The statement is incorrect. Perfectly competitive firms are price takers, which means
that they have no control over the price of their product. They must "take" the price
given to them by the market as a whole, that is, they must take the price determined
by the market demand and market supply.
Topic: Price taker
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: SB
Chapter 13 Perfect Competition
269
6) Does a perfectly competitive producer have any incentive to undercut the current market
price? Explain your answer
Answer: A perfectly competitive producer has no incentive to undercut the market price
because the producer can sell all he or she produces at the going market price. In this
case, a producer will not lower the price he or she charges because no additional
sales can be garnered. Hence it is nonsensical to undercut the market price because
the lower price means lower revenue and hence lower profit.
Topic: Price taker
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: TS
7) Why are perfectly competitive ranchers in Montana price takers?
Answer: Because one farmer's beef is identical to another farmer's, each farmer's beef is a
perfect substitute for all other farmers' beef. In addition, there are over one million
ranchers in the United States. As a result, no individual rancher can impact the
market price by increasing or decreasing production. Therefore each rancher faces a
perfectly elastic demand. Each can sell all of the beef desired at the market price, but
not one penny more. Once the market sets the price, the rancher must take as given
whatever the price might be.
Topic: Price taker
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: JC
8) "A perfectly competitive firm is called a price maker because all the firms together must
make the market price." Is the previous statement correct or incorrect? Briefly explain your
answer.
Answer: The statement is false. A perfectly competitive firm is called a "price taker" because
the firm must take whatever price the market determines. Any single firm's actions
cannot affect the market price.
Topic: Price taker
Skill: Level 1: Definition
Objective: Checkpoint 13.1
Author: WM
270
Bade/Parkin œ Foundations of Economics, Third Edition
9) If a perfectly competitive firm manufacturing chairs produces 100 more chairs, what
happens to the market price of a chair?
Answer: The price will not change. Any one perfectly competitive firm is such a small part of
the market that a change in its output has virtually no effect on the price. This result
is why the firm's marginal revenue equals its price: No matter how much (or how
little) the firm produces, the marginal revenue from one more unit always equals the
price of the product.
Topic: Price taker
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: SA
10) Pineapple growing is a perfectly competitive industry. How does the market demand curve
for pineapples compare to the demand curve for an individual pineapple grower?
Answer: The market demand curve for pineapples is downward sloping. The demand curve
for an individual pineapple grower is a horizontal line. In other words, the demand
faced by an individual grower is perfectly elastic whereas the market demand is not
perfectly elastic.
Topic: Demand
Skill: Level 1: Definition
Objective: Checkpoint 13.1
Author: JC
11) What is the shape of the demand curve faced by the perfectly competitive firm, and why?
Answer: The demand curve faced by a perfectly competitive firm is horizontal, that is, the
demand is perfectly elastic. A perfectly competitive firm is one of many sellers in the
market that produce identical products. A single firm's output is small relative to the
market demand so the firm cannot influence the market price by increasing or
decreasing its output. It can sell any quantity it chooses at the going price. Hence the
firm's demand curve is a horizontal line at the market price.
Topic: Demand
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: SA
Chapter 13 Perfect Competition
271
12) Why does the profit-maximizing level of production occur at the point where marginal
revenue equals marginal cost?
Answer: If a firm produces at a level where marginal revenue is greater than marginal cost,
more profit could be gained by increasing output. Why? Because the added revenue
(the marginal revenue) from producing another unit exceeds the added cost (the
marginal cost) of producing the unit. Therefore the firm should increase production
until no more additional profit can be earned, which occurs where marginal revenue
equals marginal cost.
Similarly, if a firm produces at a level where marginal cost exceeds marginal
revenue, the firm's profit would rise by decreasing output. In this case, the saved
costs (the marginal cost) exceed the lost revenue (the marginal revenue). Therefore
the firm should decrease production until the point at which marginal cost equals
marginal revenue.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: JC
13) If the market price faced by a perfectly competitive firm increases, in the short run how
does the firm respond?
Answer: If the market price rises, a perfectly competitive firm increases its output. Essentially
the firm moves upward along its marginal cost curve, thereby increasing the
quantity the firm will supply.
Topic: Firm's short-run supply curve
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: SA
14) What is a perfectly competitive firm's short-run supply curve?
Answer: A perfectly competitive firm's short-run supply curve is its marginal cost curve
above the minimum average variable cost.
Topic: Firm's short-run supply curve
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: MR
272
Bade/Parkin œ Foundations of Economics, Third Edition
15) If the price received by a perfectly competitive firm is less than its average variable cost,
what will the firm do in the short run? Why?
Answer: If the price is less than the average variable cost, the firm will shut down in the short
run. By shutting down, the firm will incur an economic loss equal to its fixed cost.
Whereas if the firm operated, its economic loss would be larger. Therefore the firm
minimizes its loss by shutting down.
Topic: Shut down
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: SA
16) Will a perfectly competitive firm ever produce in the short run even though it is suffering
an economic loss?
Answer: Yes, a perfectly competitive firm will continue to produce even though it is suffering
an economic loss if the price exceeds the minimum average variable cost. In this case,
even though the firm has an economic loss, if it shut down, its economic loss would
be larger.
Topic: Shut down
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: PH
17) What must be the case if a perfectly competitive firm's economic loss is less by shutting
down rather than by producing and selling some output?
Answer: If a firm's economic loss is greater when it produces and sells some output than
when it shuts down, it is the case that the price of the product is less than the average
variable cost. When the price is less than the average variable cost, the firm's
economic loss is less if it shuts down than if it produces and sells output.
Topic: Shut down
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: SB
Chapter 13 Perfect Competition
Quantity
(dozens of roses a week)
1
2
3
4
273
Price
(dollars per dozen roses)
12
12
12
12
18) Pete is a perfectly competitive rose grower. The above table gives quantities and the price
for which Pete can sell his roses.
a. What is Pete's total revenue if he sells 1 dozen roses? 2 dozen roses? 3 dozen roses? 4
dozen roses?
b. What is the marginal revenue of the 2nd dozen roses sold? Of the 3rd dozen? Of the 4th
dozen?
Answer: a. The total revenue when 1 dozen roses is sold is $12. When Pete sells 2 dozen
roses, the total revenue is $24. When 3 dozen roses are sold, the total revenue is $36.
And the total revenue when 4 dozen roses are sold is $48.
b. The marginal revenue is always $12 per dozen roses.
Topic: Total revenue, marginal revenue
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: WM
274
Bade/Parkin œ Foundations of Economics, Third Edition
19) Farmer Brown produces corn in a perfectly competitive market. Farmer Brown produces
and sells 500 bushels of corn. The market supply and demand curves are illustrated in the
above figure.
a. What is Farmer Brown's total revenue?
b. What is Farmer Brown's marginal revenue?
Answer: a. Total revenue = price ˛ quantity. The price is determined by the intersection of
the demand and supply curves, $6 a bushel. As a result, Farmer Brown's total
revenue is $6 ˛ 500 = $3,000.
b. For a perfectly competitive firm, the marginal revenue equals the price, so
Farmer Brown's marginal revenue is $6.
Topic: Total revenue, marginal revenue
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: SB
Chapter 13 Perfect Competition
Quantity
(wreaths)
0
1
2
3
4
5
6
7
8
9
Total cost
(dollars)
1
10
18
24
28
33
40
49
60
73
Total revenue
(dollars)
275
Profit or loss
(dollars)
20) The above table gives Amy's total cost schedule for producing holiday wreaths. Amy is a
perfect competitor and can sell each wreath for $9.
a. Complete the table by calculating Amy's total revenue and her profit or loss schedule.
b. When Amy is producing 4 wreaths, what is her total cost? What is her total revenue?
What is her economic profit or economic loss?
c. What number of wreaths maximizes Amy's profit?
Answer:
Quantity
(wreaths)
0
1
2
3
4
5
6
7
8
9
Total cost
(dollars)
1
10
18
24
28
33
40
49
60
73
Total revenue
(dollars)
0
9
18
27
36
45
54
63
72
81
Profit or loss
(dollars)
-1
-1
0
3
8
12
14
14
12
8
a. The completed table is above.
b. When Amy is producing 4 wreaths, her total cost is $28, her total revenue is $36,
and her economic profit is $8.
c. Amy can produce 6 or 7 wreaths, with a maximum economic profit of $14.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: SB
276
Bade/Parkin œ Foundations of Economics, Third Edition
Total revenue
Quantity
(thousands of bushels (thousands of
of corn a week)
dollars per week)
0
0
10
30
20
60
30
90
40
120
50
150
60
180
70
210
80
240
Total cost
(thousands of
dollars per week)
50
70
80
90
110
140
200
280
400
21) Jimmy grows corn. His total revenue and total cost are in the above table. What quantity of
corn maximizes his profit and what is his profit? What is the marginal revenue and
marginal cost at this quantity?
Answer: Jimmy's profit is greatest if he grows either 40,000 or 50,000 bushels of corn. His
(economic) profit at either amount is $10,000 a week. Between 40,000 and 50,000
bushels of corn, Jimmy's marginal revenue is $30,000, or $3 per bushel and his
marginal cost is $30,000, or $3 per bushel.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: WM
Chapter 13 Perfect Competition
277
Quantity Total cost
(units) (dollars)
0
3
1
6
2
12
3
21
4
33
5
49
22) The above table gives the quantity of output and the total cost for a perfectly competitive
firm that can sell all of its output at $9 per unit.
a. Find the profit maximizing level of output for this firm.
b. How much economic profit is the firm making?
Answer:
Quantity Total cost Total revenue Profit or loss
(units)
(dollars)
(dollars)
(dollars)
0
3
0
-3
1
6
9
3
2
12
18
6
3
21
27
6
4
33
36
3
5
49
45
-4
a. Total revenue equals price times quantity sold. We can find the total revenue for
this firm because the market price is a constant $9. The total revenue schedule is
given in the table above. The total profit (or loss) equals total revenue minus total
cost. The last column shows that the total profit is largest if either 2 or 3 units are
produced.
b. When the firm produces either 2 or 3 units of output, the total economic profit is
$6.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: SA
278
Bade/Parkin œ Foundations of Economics, Third Edition
Quantity
(units)
0
1
2
3
4
5
6
7
8
9
Total cost
(dollars)
400
550
600
650
740
850
990
1,140
1,400
1,690
Total revenue
(dollars)
Profit or loss
(dollars)
23) The above table shows the total cost schedule for a perfectly competitive firm. The market
price is $250 per unit. Complete the table.
Answer:
Quantity
(units)
0
1
2
3
4
5
6
7
8
9
Total cost
(dollars)
400
550
600
650
740
850
990
1,140
1,400
1,690
The completed table is above.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: PH
Total revenue
(dollars)
0
250
500
750
1,000
1,250
1,500
1,750
2,000
2,250
Profit or loss
(dollars)
-400
-300
-100
100
260
400
510
610
600
560
Chapter 13 Perfect Competition
279
Quantity Total cost
(units)
(dollars)
0
12.00
1
20.00
2
26.00
3
30.00
4
32.00
5
36.00
6
42.00
7
49.80
8
64.00
9
87.60
10
124.00
24) Acme is a perfectly competitive firm. It has the total cost schedule given in the above table.
Acme's product sells for $8.00 per unit. What amount of output is the most profitable and
what is Acme's economic profit or economic loss?
Answer: Acme's profit-maximizing level of output is 7 units. Acme's total economic profit
equals its revenue, $56.00 ($8.00 per unit ˛ 7 units), minus its total cost, $49.80 at this
level of output, or $56.00 - $49.80 = $6.20.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: TS
280
Bade/Parkin œ Foundations of Economics, Third Edition
Average
Quantity variable cost Marginal cost
(units)
(dollars)
(dollars)
1
8.00
2
7.00
6.00
3
6.00
4.00
4
5.00
2.00
5
4.80
4.00
6
5.00
6.00
7
5.40
7.80
8
6.50
14.20
9
8.40
23.60
10
11.20
36.40
25) Acme is a perfectly competitive firm. It has the cost schedules given in the above table and
has a fixed cost of $12.00. The price of Acme's product is $14.20. What is Acme's most
profitable amount of output? What is Acme's total economic profit or loss?
Answer: The profit maximizing level of output is either 7 or 8 units. Acme's total economic
profit is the economic profit per unit times the number of units produced. The
economic profit per unit equals the price minus the average total cost. To calculate
average total cost, note that when Acme produces 8 units, the average variable cost
per unit is $6.50 and the average fixed cost is $1.50, so Acme's average total cost
equals $8.00. Thus Acme makes an economic profit of $14.20 - $8.00 = $6.20 per unit.
Hence Acme's total economic profit is ($6.20) ˛ (8 units) = $49.60. Acme's total
economic profit when it makes 7 units is (except for rounding) identical.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: TS
26) Acme is a perfectly competitive firm. It has the cost schedules given in the above table and
has a fixed cost of $12.00. The price of Acme's product is $4.00. What is Acme's most
profitable amount of output? What is Acme's total economic profit or loss?
Answer: Acme's most profitable (which means, in this case, minimum loss) is output of 0
units. The price is below Acme's minimum average variable cost, so Acme shuts
down. Acme's economic loss equals its fixed costs, $12.00.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: TS
Chapter 13 Perfect Competition
281
27) The above figure illustrates a perfectly competitive wheat farmer.
a. What will be the firm's profit-maximizing price and output?
b. When the farmer produces 25,000 bushels of wheat, the difference between the firm's
average total cost and the price is at its maximum. Explain why this amount of wheat either
is or is not the profit-maximizing quantity.
Answer: a. The firm will maximize its profits by producing where its marginal revenue
equals its marginal cost, or 30,000 bushels of wheat. The price will equal the marginal
revenue, $3.00 a bushel.
b. At 25,000 bushels, the difference between average cost and price (which is the
average revenue) is indeed at the maximum, but choosing 25,000 will maximize the
profit per bushel of wheat, not the total profit. The firm is interested in maximizing
the total profit not the profit per bushel. At 30,000 bushels of wheat, the total profit is
maximized because this is the amount of output where the difference between total
revenue and total cost is at a maximum.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: SA
282
Bade/Parkin œ Foundations of Economics, Third Edition
28) The above diagram shows the cost curves for a perfectly competitive wheat farmer. At what
price does the wheat farmer shut down?
Answer: The wheat farmer shuts down if the price is less than the minimum average variable
cost. So in the figure, the wheat farmer shuts down if the price is less than $2 per
bushel.
Topic: Shut down point
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: CD
13.2 Output, Price, and Profit in the Short Run
1) Can a perfectly competitive firm earn an economic profit in the short run? Can it incur an
economic loss?
Answer: In the short run, a perfectly competitive firm can earn an economic profit or incur an
economic loss. Indeed, the firm also can earn a normal profit in the short run.
Basically, any profit or loss outcome is possible in the short run.
Topic: Economic profit, economic loss
Skill: Level 2: Using definitions
Objective: Checkpoint 13.2
Author: SA
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283
2) If the market price is less than a perfectly competitive firm's average total cost, what sort of
profit or loss is the firm earning?
Answer: If the price is less than the average total cost, the firm is incurring an economic loss.
Topic: Economic loss
Skill: Level 3: Using models
Objective: Checkpoint 13.2
Author: WM
3) What is the relationship between the price, P, and the average total cost, ATC, for a firm in
perfect competition that earns an economic profit? That earns a normal profit? That incurs
an economic loss?
Answer: If the price is greater than the average total cost, P > ATC, the firm earns an economic
profit. If the price equals the average total cost, P = ATC, the firm earns a normal
profit. If the price is less than the average total cost, P < ATC, the firm incurs an
economic loss.
Topic: Economic profit, economic loss
Skill: Level 2: Using definitions
Objective: Checkpoint 13.2
Author: MR
4) John keeps beehives and sells 100 quarts of honey per month. The honey market is perfectly
competitive, and the price of a quart of honey is $10. John has an average variable cost of $5
and an average fixed cost of $3. At 100 quarts per month, John's marginal cost is $10.
a. Is John maximizing his profit? If not, what should John do?
b. Calculate John's total revenue, total cost, and total economic profit or economic loss when
he produces 100 quarts of honey.
Answer: a. Yes, John is maximizing his profit because marginal revenue (price) equals
marginal cost.
b. Total revenue equals price times quantity = $10 ˛ 100 = $1,000.Total cost equals
average total cost times quantity = ($5 + $3) ˛ 100 = $800.Economic profit equals total
revenue minus total cost = $1,000 - $800 = $200.
Topic: Economic profit
Skill: Level 4: Applying models
Objective: Checkpoint 13.2
Author: SB
284
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5) The above diagram shows the cost curves for a perfectly competitive wheat farmer. At what
price(s) does the wheat farmer earn an economic profit? Earn a normal profit? Incur an
economic loss? How many bushels of wheat does the farmer produce if the price is $3 per
bushel? If the price is $0.50 per bushel?
Answer: At any price that exceeds the minimum of the average total cost the farmer earns an
economic profit. So the farmer earns an economic profit if the price is greater than $2
per bushel. The farmer earns a normal profit if the price equals the minimum total
cost. So the farmer earns a normal profit if the price is $2 per bushel. Finally, the
farmer incurs an economic loss if the price is less than the minimum average total
cost. So the farmer incurs an economic loss if the price is less than $2 per bushel.
If the price is $3 per bushel, the farmer produces 30,000 bushels of wheat per
year. If the price is $0.50 per bushel, the farmer has shut down because the price is
less than the minimum average variable cost and so the farmer produces 0 bushels
per year.
Topic: Economic profit
Skill: Level 4: Applying models
Objective: Checkpoint 13.2
Author: CD
Chapter 13 Perfect Competition
285
13.3 Output, Price, and Profit in the Long Run
1) "For a perfectly competitive market, an economic profit attracts new firms. But when these
firms enter the market, the price falls and the economic profit is eliminated." Are the
previous statements correct or incorrect? What is the long-run profit or loss outcome for
firms in a perfectly competitive market?
Answer: The statements are correct. As the statements point out, in the long run the economic
profit of perfectly competitive firms is eliminated by entry. Similarly, an economic
loss will be eliminated by exit. Therefore the long-run equilibrium profit for a
perfectly competitive firm is a normal profit.
Topic: Entry
Skill: Level 2: Using definitions
Objective: Checkpoint 13.3
Author: SB
2) In the long run, perfectly competitive firms cannot earn an economic profit. Why?
Answer: An economic profit attracts entry by new firms. As new firms enter the market, the
market supply increases and the market supply curve shifts rightward. The increase
in supply decreases the price. And, as the price falls, the economic profit is
eliminated.
Topic: Long-run equilibrium, entry
Skill: Level 2: Using definitions
Objective: Checkpoint 13.3
Author: SB
3) The U-pick berry market is perfectly competitive. Suppose that all U-pick blueberry farms
have the same cost curves and all are earning an economic profit. What happens as time
passes? What is the long-run equilibrium outcome?
Answer: The presence of economic profit attracts new firms into the U-pick blueberry market.
As the new firms (the new farmers) enter the market, the supply of U-pick
blueberries increases. The increase in the supply drives the price lower and decreases
the economic profits of the existing farmers. New farmers continue to enter the
market as long as there is the possibility of an economic profit. Eventually enough
new firms enter so that the price is driven so low that the economic profit is
eliminated. All the firms earn a normal profit, which will keep them in business but
will provide no incentive for new firms to enter the market. At this point, the
long-run equilibrium has been reached.
Topic: Long-run equilibrium, entry
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: WM
286
Bade/Parkin œ Foundations of Economics, Third Edition
4) When will new firms enter a perfectly competitive market? When does entry stop?
Answer: New firms will enter a perfectly competitive market as long as the existing firms are
earning an economic profit. Essentially the new firms enter in order to earn an
economic profit themselves. Entry will stop when it is no longer possible to earn an
economic profit, which occurs when the existing firms are earning a normal profit.
Topic: Long-run equilibrium, entry
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: WM
5) Describe how economic losses are eliminated in a perfectly competitive industry.
Answer: If firms are making losses, some will exit in the long run. When firms exit, the market
supply decreases and the market supply curve shifts leftward. When supply
decreases, the price rises. As the price rises, the surviving firms increase production
and their economic losses are eliminated.
Topic: Long-run equilibrium, exit
Skill: Level 2: Using definitions
Objective: Checkpoint 13.3
Author: SB
6) Pumpkin growing is a perfectly competitive industry. Suppose that pumpkin growers are
all generally suffering an economic loss. What happens as time passes? What is the
long-run equilibrium outcome?
Answer: Because the firms are generally experiencing an economic loss, as time passes some
firms will exit the market, perhaps by switching to other crops, or perhaps by closing
entirely. As farmers leave the market, the supply of pumpkins decreases. The supply
curve shifts leftward and the price of a pumpkin rises. As the price rises, the
economic losses of the remaining firms decrease. Eventually enough farmers leave
the market so that the price rises sufficiently so that the remaining firms earn a
normal profit and no longer suffer an economic loss. At that point, the long-run
equilibrium is reached because there is no further incentive for any firms to leave the
market.
Topic: Long-run equilibrium, exit
Skill: Level 4: Applying models
Objective: Checkpoint 13.3
Author: WM
Chapter 13 Perfect Competition
287
7) Suppose a farmer raising beef is earning a normal profit. Then, because of a scare about
mad cow disease, the demand for beef decreases drastically. What happens to the profits of
the beef farmer in the short run and in the long run?
Answer: In the short run, the fall in beef prices will decrease the farmer's profits. With the fall
in price, the farmer will incur an economic loss. If the price is high enough so the
revenue covers the farmer's variable costs, the farmer will continue to operate. In the
long run, if demand continues to remain depressed, some farmers will exit the
market until the remaining farmers earn a normal profit once again.
Topic: Long-run equilibrium, exit
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: SA
8) How does a decrease in the demand for wheat ultimately lead to normal profits for wheat
growers in the long run?
Answer: If the demand for wheat decreases, the price of wheat falls and many wheat farmers
incur economic losses. These losses lead to some farmers shutting down their
operations. As these farmers exit the market, the supply of wheat decreases. A
decrease in the supply of wheat pushes wheat prices back up. The process of exit and
rising prices continues until finally the price of wheat rises enough so that the
surviving wheat farmers are earning a normal profit. At this time, which occurs in
the long run, the economic losses have disappeared and no further exit occurs. The
wheat market is back in its long-run equilibrium.
Topic: Long-run equilibrium, exit
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: JC
9) Entry by competitive firms decreases the market price, while exit by competitive firms
increases the market price. Explain why firms enter or exit an industry and why these price
changes occur.
Answer: Competitive firms will enter an industry where economic profits exist in an attempt
to earn an economic profit. As new firms enter, the supply increases and the supply
curve for the product shifts rightward. The increase in supply drives the price lower.
Firms exit an industry when economic losses are incurred. As they leave, supply
decreases and the supply curve shifts leftward. The decrease in the supply forces the
price higher. Entry and exit continue until the remaining firms in the industry are
earning a normal profit.
Topic: Long-run equilibrium, entry and exit
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: PH
288
Bade/Parkin œ Foundations of Economics, Third Edition
10) In the long run, a perfectly competitive firm earns zero economic profit. What incentive
does the firm have to stay in business if it is making zero economic profit?
Answer: Zero economic profits do not mean no profit whatsoever. The firm is still making a
normal profit. A normal profit compensates the firm's owners enough to keep the
firm in business because it is equal to the owner's opportunity cost. Hence the firm
has the incentive to stay in business.
Topic: Long-run equilibrium
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: SA
11) With regard to its profits and losses, how is the short run different from the long run for a
perfectly competitive firm?
Answer: The firm can earn an economic profit, incur an economic loss in the short run, or earn
a normal profit in the short run. In the long run, however, the only possible outcome
is a normal profit. An economic profit attracts entry by new firms and economic
losses lead to exit by some firms. Thus, after entry or exit is complete in the long run,
the remaining firms will earn a normal profit.
Topic: Long-run equilibrium
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: SA
12) During the middle of the 1990s, the price of pork rose. After a couple of years the price
decreased back to about the level before the initial increase. What might have led to these
events?
Answer: There are thousands upon thousands of hog farmers in the United States. In the
middle of the 1990s, a general decrease in the demand for beef led to a large increase
in the demand for pork (the "other white meat"). As a result of the increase in market
demand, the price of pork increased dramatically. Hog farmers were getting a high
price and earning large economic profits.
In the long run, unable to prevent the flow of information to prospective hog
farmers, the word got out that economic profit was possible in this arena. Over time,
more hog farmers entered the market, which led to a large increase in the supply of
pork. As supply increased, the price of pork dropped.
Thus the higher price was the short-run result of an increase in demand. The
falling price reflected the adjustment to the long-run equilibrium, as new hog
farmers entered the market. The long run was ultimately reached and the price of
pork was more or less the same as before the increase in demand.
Topic: Long-run equilibrium
Skill: Level 5: Critical thinking
Objective: Checkpoint 13.3
Author: JC
Chapter 13 Perfect Competition
289
13) The above figure shows the cost curves of a profit-maximizing perfectly competitive firm. If
the price equals $7,
a. how much will the firm produce?
b. how much is the firm's average total, average variable, and marginal costs?
c. how much is the firm's total, total variable, and total fixed costs?
d. how much is the firm's total revenue and economic profit?
e. what will happen in this market in the long run?
Answer: a. The firm will produce 40 units of output because that is where the marginal
revenue equals the marginal cost.
b. The firm's average total cost equals $4, its average variable cost equals $3, and its
marginal cost equals $7.
c. The firm's total cost is $160 (= $4 ˛ 40), its total variable cost is $120 (= $3 ˛ 40),
and its total fixed cost is $40 (= $160 - $120).
d. The firm's total revenue is $280 (= $7 ˛ 40) and its economic profit is $120 (= $280
- $160).
e. In the long run, firms will enter the market in response to the economic profit.
The market supply curve will shift rightward, the price will fall, and the economic
profit will be eliminated.
Topic: Long-run equilibrium, entry
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: SB
290
Bade/Parkin œ Foundations of Economics, Third Edition
14) American restaurants receive their supply of baby back-ribs from American farms and
from farms in Denmark. In the figures above, the left diagram shows the perfectly
competitive market for baby back ribs in the United States. The right figure shows the
situation at Premium Standard Farm in Kansas, one of the many U.S. farms supplying these
ribs.
Now assume that the United States imposes a ban on European meat in response to the
foot-and-mouth disease that has infected livestock in Europe. (Which the United States did
Chapter 13 Perfect Competition
291
in 2001.) In particular, suppose that the U.S. ban decreases the supply by 40 tons a year.
Using the figure on the left, show the impact of this ban on the baby back rib market. Using
the figure on the right, show the impact on Premium Standard Farm in Kansas.
Answer:
The ban on European meat decreases the supply of baby back ribs and shifts the
supply curve leftward, as shown by the shift from S1 to S2. The price rises to $4 a
pound. As the figure on the right shows, the MR curve for the Premium Standard
292
Bade/Parkin œ Foundations of Economics, Third Edition
Farm will shift upward, from MR1 to MR2. As a result, the farm increases its
production to 40,000 pounds of ribs. Because the price exceeds the average total cost,
the Premium Standard Farm makes an economic profit.
Topic: Long-run equilibrium, exit
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: SA
15) Suppose the bobby pin industry is perfectly competitive. The price of a packet of bobby
pins is $2.00. Pins and Needles, Inc. is a firm in this industry and is producing 1,000 packets
of bobby pins per day at the point where the MC = MR. The average cost of production at
this output level is $1.50 per packet.
a. What is the marginal cost of the 1,000th packet?
b. Is this firm making an economic profit, a normal profit, or an economic loss? How
much?
c. Is the firm in long-run equilibrium? Why or why not?
Answer: a. The price per packet is $2, which is also the Pins and Needle's marginal revenue.
The marginal cost of the 1,000th packet is equal to marginal revenue, so for Pins and
Needles the marginal cost is $2 per packet.
b. The firm is making a $0.50 economic profit per unit (which equals the price
minus the average total cost). Because Pins and Needles produces 1,000 packets, its
total economic profit is $500.
c. The firm is making an economic profit, so it is not in long-run equilibrium. In the
long run, a perfectly competitive firm cannot earn an economic profit. The only
outcome possible in the long run is a normal profit.
Topic: Long-run equilibrium
Skill: Level 4: Applying models
Objective: Checkpoint 13.3
Author: SA