Download week3QA2c

Multiple-Choice
1. To determine the economic profit of a company,
a.
b.
c.
d.
Implicit costs are added to explicit costs.
Implicit costs are subtracted from total revenues.
Total economic costs are subtracted from total revenues.
Explicit costs are subtracted from total revenues.
Answer: c
Feedback: Profits are defined as TR - TC. Economic profits = Total revenue – (Explicit
costs + Implicit costs). One must remember that total economic costs contain all
accounting costs and opportunity costs.
2. A firm that makes zero economic profit
a.
b.
c.
d.
Must eventually go bankrupt.
Does not cover its variable costs and should shut down.
Incurs an accounting loss.
Covers all its costs including a normal profit.
Answer: d
Feedback: Firms that make zero economic profit can stay in business a long time because
they are paying all their explicit costs plus providing a normal profit to the entrepreneur.
3. The following cost should not be included in calculating accounting profit for an ice
cream shop:
a.
b.
c.
d.
Expenses for utilities.
Expenses for ice cream and packaging.
Rent for the shop.
Interest income forgone for the owner’s initial investment.
Answer: d
Feedback: Accounting profits consider only accounting, or explicit, costs. Interest income
forgone is an implicit cost.
4. Market structure does not refer to
a.
b.
c.
d.
How many firms are in an industry.
The relative size of the firms in an industry.
How companies organize their production.
The degree of competition in an industry.
Answer: c
Feedback: Market structure identifies the competitive nature of the industry, not the
internal workings of the firm.
5. Perfect competition is characterized by
a.
b.
c.
d.
A few sellers.
Firms usually earning economic profits.
Easy entry of new firms.
A firm’s product being highly differentiated.
Answer: c
Feedback: Easy entry is an essential feature of perfect competition. If firms are free to
enter, they can compete for any economic profits other firms may be earning.
6. An example of a perfectly competitive industry is
a.
b.
c.
d.
Automobile manufacturing.
Cereal production.
Small farms.
Computer operating system software development.
Answer: c
Feedback: Small farms are characterized by all the features of a highly competitive
industry, including easy entry, homogeneous products, large number of firms, and being
price takers.
7. For perfectly competitive firms,
a. Price equals marginal revenue.
b. Profits are maximized at an output level where marginal revenue equals marginal
cost.
c. Normal profits are earned in the long run.
d. All of the answers are correct.
Answer: d
Feedback: A perfectly competitive must sell its product at the prevailing price, so its
change in revenue for the last unit will always be the market price. As long as MR > MC,
it can still earn some profit. Only when MR = MC is there no additional profit to make,
so a firm will always produce up to MR = MC. Perfectly competitive firms do not earn
economic profits in the long run due to firms entering the market and taking away the
available economic profits.
8. A firm has an incentive to increase output as long as
a. Price is greater than marginal revenue.
b. Marginal cost is greater than marginal revenue.
c. It is earning revenues.
d. Marginal cost is less than marginal revenue.
Answer: d
Feedback: When MR > MC, a firm can sell its product for more than it costs to produce.
In this situation, the firm has an incentive to increase output.
9. The shutdown point is where
a.
b.
c.
d.
A firm is losing money.
A firm’s average total cost per unit exceeds product price.
A firm’s average variable cost per unit exceeds product price.
Total costs are higher than total revenues.
Answer: c
Feedback: A firm will shut down in the short run when it cannot cover its average
variable costs of production.
10. To maximize profits, a firm in pure competition will produce where
a.
b.
c.
d.
P = VC.
P = MC.
P > 0.
P = TC.
Answer: b
Feedback: If the price of a product is $4 and the marginal cost of producing that unit is
$4, a firm should produce that level of output. Given an upward-sloping MC curve, any
output level other than this reduces profits.
Auxiliary Problems
1. What is the difference, if any, between “accounting profit” and “economic profit”?
2. How much market power does a firm in a perfectly competitive industry have? Compare this
to a firm in a monopolistic industry.
3. A firm expects to lose $50,000 per quarter in the short run. Its quarterly fixed costs are
$80,000. Should the firm shut down in the short run?
4. The U.S. commercial airline industry is an example of a(n) ___________ industry.
5. Highly competitive industries consist of (many; at least two; one) firm(s). A competitive firm
sells a(n) (different; identical; similar) product when compared to other firms. New entrants
(are blocked; rarely occur; occur when economic profits exist).
Answers
1. Accounting profit is defined as total revenue minus total explicit cost whereas economic
profit is defined as total revenue minus total economic (explicit and implicit) cost. In this
way, normal profit is a subset of economic profit.
2. A perfectly competitive firm has no appreciable market power. A monopolist has a great deal
of market power.
3. No. If the firm shuts down this quarter it will lose $80,000. If it operates, it will cut its losses
to $50,000, so it should operate.
4. Oligopolistic
5. Many; identical; occur when economic profits exist
1. If a firm can change market prices by altering its output, then it
A. Has market power.
B. Faces a horizontal demand curve.
C. Is a price taker.
D. Is a competitive firm.
A firm that has market power will have the ability to control the market price for the good it
sells, unlike a perfectly competitive firm that risks losing all of its customers, who will shop
elsewhere, if it increases the price of its product.
2. A perfectly competitive firm is a price taker because
A. The price of the product is determined by many buyers and sellers.
B. It has market power.
C. Market supply is upward-sloping.
D. Its products are differentiated.
A perfectly competitive firm risks losing all of its customers, who will shop elsewhere, if it
increases the price of its product above the market-established price. Therefore, it is compelled to
take the market price that is determined by the interaction of supply and demand.
3. If the equilibrium price in a perfectly competitive market for walnuts is $4.99 per pound, then
an individual firm in this market can
A. Not sell additional walnuts unless the firm lowers its price.
B. Not sell additional walnuts at any price because the market is at equilibrium.
C. Sell an additional pound of walnuts at $4.99.
D. Sell more only by increasing its advertising budget.
An individual firm in a perfectly competitive market is so small relative to the entire market that
it confronts a horizontal demand curve (perfectly elastic demand) for its output. It does not need
to lower its price to sell more; it can sell as much as it can produce at the market price.
4. The difference between the total revenue and total cost curves at a given output is equal to
A. Total profit.
B. Profit per unit.
C. Average revenue.
D. Average total cost.
Profit is the difference between total revenue and total cost. It is represented as the vertical
distance between the total revenue curve and the total cost curve.
5. For perfectly competitive firms, price
A. Is greater than marginal revenue.
B. Is equal to marginal revenue.
C. Is less than marginal revenue.
D. And marginal revenue are not related.
Because a competitive firm can sell all its output at the prevailing price, the marginal revenue
will always be equal to price, and the MR curve will be equal to the demand curve.
6. If a perfectly competitive firm is producing a rate of output at which MC exceeds price, then
the firm
A. Must have an economic loss.
B. Can increase its profit by increasing output.
C. Can increase its profit by decreasing output.
D. Is maximizing profit.
If MC exceeds price, a firm is spending more to produce that extra unit than it is getting back,
and total profits will decline. Hence a firm will want to decrease production whenever price is
less than MC.
7. A competitive firm should always continue to operate in the short run as long as
A. P < ATC.
B. P < AVC.
C. MR > AVC.
D. MR > MC.
If the price (or MR) is greater than AVC, then a perfectly competitive firm is losing less than its
fixed costs and should continue producing in the short run in order to minimize its losses or
maximize its profits.