Download CHAPTER 10: Organizing Production (Pg

CHAPTER 11: Perfect Competition (Pg. 238-249)
Answers to the Review Quizzes
Review Quizzes Page 239
1. One firm’s output is a perfect substitute for another firm’s output. This implies that each
firm cannot unilaterally influence the market price for which it can sell its good or service. It
must accept, or “take” the market equilibrium price - hence the term, price taker.
2. The market demand for the goods and services in a perfectly competitive market is
downward sloping. However, no single firm in this market can determine the price at which
to sell its output. This means that a price taker firm must take the equilibrium market price
as given, and the firm faces a perfectly elastic demand curve.
3. The perfectly competitive firm’s demand curve is a horizontal line at the market price. This
means that the price it receives is the same every unit sold. The marginal revenue received
by the firm is the change in total revenue from selling one more unit, which is the constant
market price. This means the perfectly competitive firm’s demand curve is the same as its
marginal revenue curve.
4. Total revenue equals the price of a firm’s output multiplied by the number of units of output
sold, or P  Q. If the firm can sell each and every unit at a constant market price, then the
addition to total revenue for each unit sold will be constant. This means the slope of the total
revenue curve is positive and linear.
Review Quizzes Page 245
1. A firm’s profit is maximized by producing the level of output at which marginal revenue for
the last unit produced equals its marginal cost, or MR = MC. In a perfectly competitive
market, MR is equal to the market price P for all levels of output. This implies that a
perfectly competitive firm will always maximize profit by producing output where P = MC.
2. The lowest price a firm will produce positive output is that price which equals the firm’s
minimum AVC. At this price, the firm has just enough total revenue to cover its total
variable costs. The firm’s loss is equal to its fixed costs. At any lower market price, the
firm’s loss would be greater than its fixed costs. This implies that the firm can avoid losses
that are greater than its fixed cost by shutting down its plant and stopping production.
3. The firm will produce output as long as it receives a price greater than the min AVC and it
will choose the level of output where MC = P. This means the firm’s supply curve is the
firm’s MC curve above min. AVC.
4. A perfectly competitive industry’s short-run supply curve equals the horizontal summation of
each individual firm’s supply curve. That is, the amount supplied by the total industry equals
the sum of what each firm in the industry supplies at a given price.
2
Review Quizzes Page 249
1. When a firm in a perfectly competitive market is producing the quantity that maximizes
profit, its marginal cost is equal to the marginal revenue. Because the marginal revenue is
equal to the market price, this means that the marginal cost is equal to the marginal revenue
is equal to the market price.
2. When the existing firms in a perfectly competitive industry experience economic profit, firms
from outside the industry enter the market, increasing market supply. The market supply
curve shifts rightward, driving the equilibrium market price down and lowering the firm’s
profits in the industry. In the long run, the market price falls to a level such that the firms in
the market earn only a normal profit. The equilibrium market output has increased because
of the entry of new firms.
3. When the existing firms in a perfectly competitive industry experience economic losses,
firms exit the industry, decreasing market supply. This shifts the market supply curve
leftward, driving the equilibrium market price up and raising firm profits in the industry. In
the long run, the market price returns to the original market equilibrium level, equilibrium
market output has decreased, and economic profit for each firm remaining in the industry
returns to zero.
Review Quizzes Page 253
1. A permanent decrease in demand decreases the market quantity, and the market price falls
below ATC for each firm. In the short run, firms in the industry experience an economic
loss, which leads to firms exiting the industry. This exit shifts the industry supply curve
leftward, raising the market price as the market quantity continues to decrease. The increase
in market price shrinks the economic loss for each remaining firm. Exit continues until the
price again equals the minimum point on each firm’s ATC curve. At this point, firms return
to zero economic profit and exit stops. In the long run, the market price returns to the
original level, market output has decreased, and economic profit for each firm returns to zero.
2. A permanent increase in demand increases the market quantity, and the market price rises
above ATC for each firm. In the short run, firms in the industry experience an economic
profit, attracting firms from outside the industry to enter the industry. This entry shifts the
industry supply curve rightward, decreasing the market price as the market quantity
continues to increase. The fall in the market price shrinks the firms’ economic profit until
the price again equals the minimum point on each firm’s ATC curve. At this point, firms
return to zero economic profit and entry stops. In the long run, the market price returns to the
original level, market output has increased, and economic profit for each firm returns to zero.
3. Technological advances result in lower cost curves for the firm that adopts them and initially
these firms earn an economic profit. This causes two actions to occur in the market: (i) firms
from outside the industry that have adopted the new technology enter the market, and (ii)
firms with old technology either exit the market or adopt the new technology. These two
actions cause the industry supply curve to shift rightward, decreasing market price and
increasing market quantity. In the long run, all firms in the industry will be new technology
3
firms, economic profit for each firm will return to zero, market quantity will increase, and
market price will fall to the new minimum ATC for each firm.
Answers to the Problems
1. a. Quick Copy’s profit-maximizing quantity is 80 pages an hour. Quick Copy maximizes
its profit by producing the quantity at which marginal revenue equals marginal cost. In
perfect competition, marginal revenue equals price, which is 10 cents a page. Marginal cost
is 10 cents when Quick Copy produces 80 pages an hour.
b. Quick Copy’s profit is $2.40 an hour. Profit equals total revenue minus total cost. Total
revenue equals $8.00 an hour (10 cents a page multiplied by 80 pages). The average total
cost of producing 80 pages is 7 cents a page, so total cost equals $5.60 an hour (7 cents
multiplied by 80 pages). Profit equals $8.00 minus $5.60, which is $2.40 an hour.
c. The price will fall in the long run to 6 cents a page. At a price of 10 cents a page, firms
make economic profit. In the long run, the economic profit will encourage new firms to
enter the copying industry. As they do, the price will fall and economic profit will
decrease. Firms will enter until economic profit is zero, which occurs when the price is 6
cents a copy (price equals minimum average total cost).
2. a. Jerry’s profit-maximizing quantity is 300 ice cream cones a day. Jerry’s maximizes its
profit by producing the quantity at which marginal revenue equals marginal cost. In
perfect competition, marginal revenue equals price, which is $3 a cone. Marginal cost is
$3 when 300 cones a day are produced.
b. Jerry’s profit is $150 a day. Profit equals total revenue minus total cost. Total revenue
equals $900 a day ($3 a burger multiplied by 300 cones). The average total cost of
producing 300 ice cream cones is $2.50 a cone, so total cost equals $750 a day ($2.50
multiplied by 300 cones). Profit equals $900 minus $750, which is $150 a day.
c. In the long run, the price will fall to $2 a cone. At a price of $3 a cone, firms make
economic profit. In the long run, the economic profit will encourage new firms to enter
and set up an ice cream stand on the beach. As they do, the price will fall and economic
profit will decrease. Firms will enter until economic profit is zero, which occurs when
the price is $2 a cone (price equals minimum average total cost).
3. a. (i) At $14 a pizza, Pat’s profit-maximizing output is 4 pizzas an hour and economic
profit is $10 an hour. Pat’s maximizes its profit by producing the quantity at which
marginal revenue equals marginal cost. In perfect competition, marginal revenue
equals price, which is $14 a pizza. Marginal cost is the change in total cost when
output is increased by 1 pizza an hour. The marginal cost of increasing output from 3
to 4 pizzas an hour is $13 ($54 minus $41). The marginal cost of increasing output
from 4 to 5 pizzas an hour is $15 ($69 minus $54). So, the marginal cost of the fourth
pizza is half-way between $13 and $15, which is $14. Marginal cost equals marginal
revenue when Pat produces 4 pizzas an hour.
Economic profit equals total revenue minus total cost. Total revenue equals $64 ($14
multiplied by 4). Total cost is $54, so economic profit is $10.
4
(ii) At $12 a pizza, Pat’s profit-maximizing output is 3 pizzas an hour and economic
profit
revenue equals marginal cost. Marginal revenue equals price, which is $12 a pizza.
Marginal cost of increasing output from 2 to 3 pizzas an hour is $11 ($41 minus $30).
The marginal cost of increasing output from 3 to 4 pizzas an hour is $13. So, the
marginal cost of the third pizza is half-way between $11 and $13, which is $12.
Marginal cost equals marginal revenue when Pat produces 3 pizzas an hour.
Economic profit equals total revenue minus total cost. Total revenue equals $36 ($12
(iii)At $10 a pizza, Pat’s profit-maximizing output is 2 pizzas an hour and economic
ntity at which
marginal revenue equals marginal cost. Marginal revenue equals price, which is $10 a
pizza. Marginal cost of increasing output from 1 to 2 pizzas an hour is $9 ($30 minus
$21). The marginal cost of increasing output from 2 to 3 pizzas an hour is $11. So,
the marginal cost of the second pizza is half-way between $9 and $11, which is $10.
Marginal cost equals marginal revenue when Pat produces 2 pizzas an hour.
Economic profit equals total revenue minus total cost. Total revenue equals $20 ($10
b. Pat’s shutdown point is at a price of $10 a pizza. The shutdown point is the price that
equals minimum average variable cost. To calculate total variable cost, subtract total
fixed cost ($10, which is total cost at zero output) from total cost. Average variable cost
equals total variable cost divided by the quantity produced. For example, the average
variable cost of producing 2 pizzas is $10 a pizza. Average variable cost is a minimum
when marginal cost equals average variable cost. The marginal cost of producing 2
pizzas is $10. So, the shutdown point is a price of $10 a pizza.
c. Pat’s supply curve is the same as the marginal cost curve at prices equal to or above $10 a
pizza and the y-axis at prices below $10 a pizza.
d. Pat will exit the pizza industry if in the long run the price is less than $13 a pizza. Pat’s
Pizza Kitchen will leave the industry if it incurs an economic loss in the long run. To
incur an economic loss, the price will have to be below minimum average total cost.
Average total cost equals total cost divided by the quantity produced. For example, the
average total cost of producing 2 pizzas is $15 a pizza. Average total cost is a minimum
when it equals marginal cost. The average total cost of 3 pizzas is $13.67, and the
average total cost of 4 pizzas is $13.50. Marginal cost when Pat’s produces 3 pizzas is
$12 and marginal cost when Pat’s produces 4 pizzas is $14. At 3 pizzas, marginal cost is
less than average total cost; at 4 pizzas, marginal cost exceeds average total cost. So
minimum average total cost occurs between 3 and 4 pizzas - $13 at 3.5 pizzas an hour.
4. a. (i) Luigi’s profit-maximizing output 5 plates an hour and economic profit is $18. Luigi’s
maximizes its profit by producing the quantity at which marginal revenue equals
marginal cost. In perfect competition, marginal revenue equals price, which is $24 a
plate. Marginal cost is the change in total cost when output is increased by 1 plate an
hour. The marginal cost of increasing output from 4 to 5 plates an hour is $22 ($102
minus $80). The marginal cost of increasing output from 5 to 6 plates an hour is $26
($128 minus $102). So, the marginal cost of the fifth plate is half-way between $22
and $26, which is $24. Marginal cost equals marginal revenue when Luigi produces
5
5 plates an hour. Economic profit equals total revenue minus total cost. Total
revenue equals $120 ($24 multiplied by 5). Total cost is $102, so economic profit is
$18.
(ii) Luigi’s profit-maximizing output 4 plates an hour and economic profit is zero.
Luigi’s maximizes its profit by producing the quantity at which marginal revenue
equals marginal cost. Marginal revenue equals price, which is $20 a plate. The
marginal cost 4th plate an hour is $20. The profit-maximizing output is 4 plates an
hour. Economic profit equals total revenue minus total cost. Total revenue equals
$80 ($20 multiplied by 4). Total cost is $80, so economic profit is zero.
(iii)Luigi’s profit-maximizin
Marginal
revenue equals price, which is $12 a plate. The marginal cost is $12 if Luigi’s
produces 2 plates an hour. If Luigi’s produces 2 plates an hour, total revenue is $24
($12 multiplied by 2). Total cost is $48, so Luigi’s would incur an economic loss of
$24 if she produces 2 plates. By shutting down, Luigi will incur a loss equal to total
fixed costs, which are $14 (total cost when output is zero).
b. Luigi’s shutdown point is at a price of $16 a plate. The shutdown point is the price that
equals minimum average variable cost. To calculate total variable cost, subtract total
fixed cost ($14, which is total cost at zero output) from total cost. Average variable cost
equals total variable cost divided by the quantity produced. For example, the average
variable cost of producing 3 plates is ($62 minus $14) divided by 3, which equals $16 a
plate. Average variable cost is a minimum when marginal cost equals average variable
cost. The marginal cost of producing 3 plates is $16. So, the shutdown point is a price of
$16 a plate.
c.
revenue is zero. Total variable cost is zero and so total cost equals total fixed cost, which
is $14. Luigi’s incurs a loss of $14 at the shutdown point.
d. Firms with costs identical to Luigi’s will enter at any price above $20 a plate. Firms will
enter an industry in the long run when firms currently in the industry are making
economic profit. Firms with costs identical to Luigi’s will make economic profit when
the price exceeds minimum average total cost, which is $20 a plate.
5. a. The market price is $8.40 a cassette. The market price is the price at which the quantity
demanded equals the quantity supplied. The firm’s supply curve is the same as its
marginal cost curve at prices above minimum average variable cost. Average variable
cost is a minimum when marginal cost equals average variable cost. Marginal cost
equals average variable cost at the quantity 250 cassettes a week. So, the firm’s supply
curve is the same as the marginal cost curve for the outputs equal to 250 cassettes or
more. When the price is $8.40 a cassette, each firm produces 350 cassettes and the
quantity supplied by the 1,000 firms is 350,000 cassettes a week. The quantity demanded
at $8.40 is 350,000 a week.
b. The industry output is 350,000 cassettes a week.
c. Each firm produces 350 cassettes a week.
d. Each firm incurs an economic loss of $581 a week. Each firm produces 350 cassettes at
an average total cost of $10.06 a cassette. The firm can sell the 350 cassettes for $8.40 a
cassette. The firm incurs a loss on each cassette of $1.66 and incurs an economic loss of
$581a week.
6
e. In the long run, some firms exit the industry because they are incurring economic losses.
f. The number of firms in the long run is 750. In the long run, as firms exit the industry, the
price rises. In long-run equilibrium, the price will equal the minimum average total cost.
When output is 400 cassettes a week, marginal cost equals average total cost and average
total cost is a minimum at $10 a cassette. In the long run, the price is $10 a cassette.
Each firm remaining in the industry produces 400 cassettes a week. The quantity
demanded at $10 a cassette is 300,000 a week. So, the number of firms is 300,000
cassettes divided by 400 cassettes per firm, which is 750 firms.
6. a. The market price is $8.40 a cassette. The market price is the price at which the quantity
demanded equals the quantity supplied. The firm’s supply curve is the same as its
marginal cost curve at prices above minimum average variable cost. Average variable
cost is a minimum when marginal cost equals average variable cost. Marginal cost
equals average variable cost at the quantity 250 cassettes a week. So, the firm’s supply
curve is the same as the marginal cost curve for the outputs equal to 250 cassettes or
more. When the price is $8.40 a cassette, each firm produces 350 cassettes and the
quantity supplied by the 1,000 firms is 350,000 cassettes a week. The quantity demanded
at $8.40 is 350,000 a week.
b. The industry output is 350,000 cassettes a week.
c. Each firm produces 350 cassettes a week.
d. Each firm incurs an economic loss of $1,561 a week. Each firm produces 350 cassettes at
an average total cost of $12.86 a cassette. The firm can sell the 350 cassettes for $8.40 a
cassette. The firm incurs a loss on each cassette of $4.46 and incurs an economic loss of
$1,561a week.
e. In the long run, some firms exit the industry because they are incurring economic losses.
f. The number of firms in the long run is 500. In the long run, as firms exit the industry, the
price rises. In the long-run equilibrium, the price equals the minimum average total cost.
When output is 450 cassettes a week, marginal cost equals average total cost and average
total cost is a minimum at $12.40 a cassette. In the long run, the price is $12.40 a
cassette. Each firm remaining in the industry produces 450 cassettes a week. The
quantity demanded at $12.40 a cassette is 225,000 a week. So, the number of firms is
225,000 cassettes divided by 450 cassettes per firm, which is 500 firms.
7. a. The market price is $7.65 a cassette. When the price is $7.65 a cassette, each firm
produces 300 cassettes and the quantity supplied by the 1,000 firms is 300,000 cassettes a
week. The quantity demanded at $7.65 is 300,000 a week.
b. The industry output is 300,000 cassettes a week.
c. Each firm produces 300 cassettes a week.
d. Each firm makes an economic loss of $834 a week. Each firm produces 300 cassettes at
an average total cost of $10.43 a cassette. The firm can sell the 300 cassettes for $7.65 a
cassette. The firm incurs a loss on each cassette of $2.78 and incurs an economic loss of
$834 a week.
e. In the long run, some firms exit the industry because they are incurring economic losses.
f. The number of firms in the long run is 500. In the long run, as firms exit the industry, the
price rises. Each firm remaining in the industry produces 400 cassettes a week. The
7
quantity demanded at $10 a cassette is 200,000 a week. So, the number of firms is
200,000 cassettes divide by 400 cassettes per firm, which is 500 firms.
8. a. The market price is $7.65 a cassette. When the price is $7.65 a cassette, each firm
produces 300 cassettes and the quantity supplied by the 1,000 firms is 300,000 cassettes a
week. The quantity demanded at $7.65 is 300,000 a week.
b. The industry output is 300,000 cassettes a week.
c. Each firm produces 300 cassettes a week.
d. Each firm incurs an economic loss of $1,815 a week. Each firm produces 300 cassettes at
an average total cost of $13.70 a cassette. The firm can sell the 300 cassettes for $7.65 a
cassette. The firm incurs a loss on each cassette of $6.05 and incurs an economic loss of
$1,815 a week.
e. In the long run, some firms exit the industry because they are incurring economic losses.
f. The number of firms in the long run is 222. In the long run, as firms exit the industry, the
price rises. In long-run equilibrium, the price will equal the minimum average total cost.
When output is 450 cassettes a week, marginal cost equals average total cost and average
total cost is a minimum at $12.40 a cassette. In the long run, the price is $12.40 a
cassette. Each firm remaining in the industry produces 450 cassettes a week. The
quantity demanded at $12.40 a cassette is approximately 100,000 a week. So, the number
of firms is 100,000 cassettes divided by 450 cassettes per firm, which is 222 firms.