Multiple Choice Tutorial Chapter 8 Perfect Competition 1

Multiple Choice Tutorial Chapter 8 Perfect Competition

1. Economic theory assumes that the goal of firms is to maximize a. sales b. total revenue c. profit d. price C. Microeconomics is the study of the economic behavior in particular markets, such as the market for computers or for unskilled labor. A part of microeconomics is price theory, what is the best price to charge and quantity to produce for a firm to maximize its profits? 2

2. Market structure a. has no influence on a firm’s decision making b. applies only to industries regulated by the government c. is determined entirely by demand conditions in the industry d. influences the forms of competition among firms D. Economists recognize four distinct types of markets, they are: perfect competition, monopolistic competition, oligopoly, and monopoly. 3

3. A market is perfectly competitive when a. there are two virtually identical firms which are equally matched and selling in the same market b. government authorities set price at an acceptable level which forces firms to compete on everything except price c. all sellers must charge approximately the same price for comparable products C. Firms charge approximately the same price because they have no incentive to charge a price other than that which is determined by the market, market demand market supply. 4

4. Which of the following describes the market structure of perfect competition? a. many firms, low barriers to entry, some control over price, and product differentiation b. many firms, low barriers to entry, no control over price, and identical products with no differentiation c. a few firms producing similar products, significant barriers to entry, and some control over price B. For example, there are many potato farmers, anyone can plant potatoes, and the potatoes of one farmer cannot be distinguished from the potatoes of another farmer. 5

5. Homogeneous products are a. rare and expensive b. patented and licensed c. highly differentiated d. uniform or standardized D. The term homo means “the same. ” For example, all potatoes are the same, one potato cannot be distinguished from another. 6

6. The economic model of perfect competition is a. not useful because most firms and industries in the real world are perfectly competitive c. only useful in markets created and controlled by the government d. useful because it demonstrates how market structure can affect resource allocation, prices, and output D. Sometimes the best we can do is approximate reality, but even so, this gives us an idea of how the real-world works. 7

7. Which real-world market closely approximates perfect competition? a. most agricultural markets b. automobile manufacturers c. state universities d. cable television services A. Most agricultural markets are perfectly competitive because each involves a homogeneous product, there is easy entry and exit, and farmers can sell all units they bring to market providing they are willing to sell at the market price. 8

8. The demand curve facing a perfectly competitive firm is a. perfectly elastic b. perfectly inelastic c. unit elastic d. downward-sloping A. A perfectly elastic demand curve means that a change in price has an infinite effect on quantity demanded, the curve is perfectly horizontal at the market price. At the market price a farmer can sell all units brought to market, but if he charges a higher price, he will sell no units; why would consumers pay a higher price if they can buy exactly the same 9 thing at a lower price from many competitors.

9. Perfectly competitive firms have no individual control over the a. quantity of output produced b. quantities of inputs used c. price of the product d. type of goods produced C. For example, any farmer can charge whatever price he wants for his product, but he had no incentive to charge other than the market price. If he charges more, he will sell zero units, he will not charge less because he can sell all units brought to market at the market price. 10

10. Which of the following is not true with regard to economic profit? a. economic profit equals total revenue minus total cost b. economic profit excludes implicit cost c. economic profit is any profit greater than a normal profit d. firms attempt to maximize economic profit B. Normal profit is an example of implicit costs. Normal profit is the minimum amount of money that will keep a business owner operating the business. Because this is a necessary expense of operating a business, we include normal profit as part of our cost data. 11

11. Perfectly competitive firms respond to changing short-run market conditions by varying a. both c and d b. advertising campaigns c. output d. price C. A firm that is part of a perfectly competitive market will charge the market price, that is, they are price takers; but they do have a choice of how many units to produce. 12

12. If a firm shuts down in the short run and produces no output, its total cost is a. zero b. equal to variable cost c. equal to fixed cost d. explicit costs only C. To shut down does not mean that the firm goes out of business; it means that the firm simply ceases production. Why will a firm continue to operate even though it is making a loss? Because its losses are less than its fixed costs, costs that have to be paid whether the firm continues to operate or not. 13

13. The total revenue curve for a perfectly competitive firm a. is a vertical line intersecting the horizontal axis b. is a horizontal line at the market price c. starts part way up the vertical axis, sloping upward in a backwards-S curve d. is a straight line starting from the origin and sloping upward D. The total revenue curve is a straight line sloping upward from the origin because a perfectly competitive firm can sell all units brought to market at the same price, the market price. 14

14. The total revenue curve for a perfectly competitive firm is a. directly and proportionately related to output b. directly or inversely related to output, depending on the price elasticity of demand c. inversely related to output d. inversely related to price A. In other types of markets, a firm can sell more units if it lowers the price, and except for a discriminating monopolist, the price cut has to apply to all identical units at one point in time. Not so in a perfectly competitive market. 15

15. Marginal revenue is a. total revenue minus total cost b. total revenue divided by quantity of output c. the change in total revenue divided by the change in output d. the change in total revenue divided by the change in the quantity of an input used C. The word margin means the last unit. Marginal revenue is the measure of how much revenue is added to total revenue by producing the last unit of output. 16

16. The slope of the total revenue curve equals a. marginal revenue, which equals price for a perfectly competitive firm b. marginal revenue, which is greater than price for a perfectly competitive firm c. marginal revenue, which is less than price for a perfectly competitive firm d. average revenue, which is greater than price for a perfectly competitive firm A. The slope of a line is the measure of a change vertically and the change horizontally; sometimes it is referred to as the “rise” divided by the “run. ” In perfect competition, the rise per unit is always the 17 market price.

17. For perfectly competitive firms, what is the relationship between market price (P), average revenue (AR), and marginal revenue (MR)? a. P = AR = MR b. P > AR = MR c. P = AR > MR d. P = AR < MR A. Price equals average revenue because all units are sold for the same price, therefore, total revenue divided by quantity will always equal the price. Average revenue always equals marginal revenue because no matter the number of units sold, the same price is 18 added to total revenue.

18. The golden rule of profit maximization states that any firm maximizes profit by producing where a. demand is unit elastic, and total revenue is greatest b. price equals average revenue c. price equals marginal cost d. marginal revenue equals marginal cost D. If marginal revenue is greater than marginal cost, a firm will produce that unit of output because it can make a profit on that last unit of output. A firm will not produce that last unit of output where marginal revenue is less than marginal cost because a loss would be made on 19 that last unit of output.

19. Average revenue is a. total revenue minus total cost b. total revenue divided by quantity of output c. total revenue divided by quantity of input d. the change in total revenue divided by the change in output B. Average always means the total divided by number of units. Revenue means money in, that is, price times quantity. So average revenue means total revenue divided by units of output. 20

20. If average revenue equals average total cost, a. total revenue is maximized b. average revenue is maximized c. economic profit is maximized d. economic profit is zero D. When average revenue equals average cost, total revenue equals total cost. Because we include normal profit (the minimum amount of money that will keep a business owner operating the business) as a part of our cost data, when TR equals TC we say that the firm is making zero economic profits, or it is exactly breaking even. 21

21. Total revenue minus total cost equals a. total economic profit b. total accounting profit c. a normal profit d. economic profit per unit of output D. Revenue minus cost is either profit or loss, depending on whether revenues are greater or less than costs. When revenue is greater than cost, an economic profit (profit) is being made. If revenues equal costs, a normal profit is being made. If revenues are less than costs, the firm experiences a loss. 22

22. On a graph showing a perfectly competitive firm’s demand curve, average total cost curve, and marginal cost curve, total economic profit is represented by the a. length of a vertical line b. length of a horizontal line c. area of a rectangle d. area of a triangle C. Profits are maximized at the number of units where marginal revenue equals marginal cost. On this vertical line, the difference between AR and AC is the width of the rectangle and from zero to the number of units (where MR = MC) is the length of the rectangle. 23

23. To maximize profit, a perfectly competitive firm which decides not to shut down will choose the rate of output at which a. price is highest b. price minus average total cost is maximized c. price equals marginal cost d. total revenue is maximized C. In a perfectly competitive market, price always equals marginal revenue because no matter how many units are sold the market price is always added to the total revenue. Therefore, when we say that price equals marginal revenue, we are also saying the marginal revenue equals marginal cost. 24

24. A perfectly competitive firm will produce at an economic loss (negative profit) in the short run rather than discontinue production if there is a rate of output at which price a. exceeds average variable cost b. exceeds average fixed cost c. exceeds average total cost d. equals marginal cost A. When price exceeds average fixed cost (at the level of output where MR = MC) the firm’s loss is less than its fixed cost. Therefore, it will lose less money if it continues to operate than it would incur if it were to close down. 25

25. A perfectly competitive firm will produce at an economic loss (negative profit) in the short run rather than discontinue production if there is a rate of output at which a. marginal revenue equals marginal cost b. total revenue equals total cost c. total revenue exceeds total cost d. total revenue exceeds total variable cost D. This is the same as the previous question because when average revenue exceeds average cost, total revenue exceeds total cost. 26

26. A perfectly competitive firm producing 100 units of output faces the following facts: Average total cost is $20 Average variable cost is $12 Marginal cost is $18 Price of the product is $18 The firm should a. stay open b. raise the price of its product c. shut down (reduce output to zero) A. Average loss equals AR ($18) minus AC ($20) or $-2; average fixed cost equals AC ($20) minus AVC ($12) or -$8). So if this firm stays open it will lose on the average $2, but if it closes down it will lose an average $8. So 27 this firm should stay open.

27. A perfectly competitive firm faces the following facts: Price of the product is $22 Marginal cost is $20 and increasing The firm should a. produce more output b. reduce the production without shutting down c. shut down (reduce output to zero) A. It should increase production because MR > MC. The fact that the MC curve is increasing is pertinent because its possible that MR can intersect the MC curve at a point where it is decreasing, more units produced in this case will result in MR being greater then MC. 28

P Last slide viewed MC 99 90 77 50 45 ATC AVC D = MR =AR Exhibit 21 -1 10 12 20 Q 29

28. The purely competitive firm in Exhibit 21 -1 should a. close down b. produce 5 units of output c. product 10 units of output d. produce 12 units of output D. MR = MC at 12 units of output. For each unit it produces beyond 12 units it will lose money on each unit of output. 30

29. The maximum economic profit (or minimum economic loss) for the firm in Exhibit 21 -1 would be a a. loss of $540 b. loss of $480 c. loss of $60 d. loss of $490 B. MR = MC at 12 units of output. At 12 units average revenue (AR) is $50 and average total cost (ATC) is $90 minus $50 equals $40, which is average loss at 12 units (we know it is a loss because ATC is > then AR at 12 units). Total loss is 12 x $40 which is $480. 31

30. The firm in Exhibit 21 -1 a. will close immediately b. is earning a short-run economic profit c. is earning a short-run economic loss d. is operating in the long run C. If this firm were to produce any other but 12 units of output it would lose more money. 32

31. The profit maximizing firm in Exhibit 21 -1 a. has a profit per unit of $5 b. is incurring a loss per unit of $40 c. is incurring a loss per unit of $49 d. is incurring a loss per unit of $108 B. At 12 units AR is $50 and AC is $90 so average loss is equal to $40. 33

32. The firm in Exhibit 21 -1 a. has both c and d b. has fixed costs equal to $490 c. should close down immediately to minimize losses d. has fixed costs equal to $540 D. Average fixed cost (AFC) at 12 units is $45 (ATC minus AVC or $90 -$45) and therefore total loss is $540 ($45 x 12). 34

P Last slide viewed S M P MC ATC D = MR =AR J Exhibit 21 -2 U AVC X B C Q 35

33. The profit maximizing firm in Exhibit 21 -2 a. finds both b and d to be the case b. is incurring economic losses c. breaks even d. should close immediately C. MR = MC at C units of output. At C units of output AR = ATC, so total revenue equals total cost. Where total revenue equals total cost we say that the firm is breaking even, which means that is it making a normal profit. Remember, because normal profit (the minimum amount of profit that will keep a business owner operating the business) is a necessary expense, it is included as a cost. 36

34. In order to maximize profit or minimize losses, the firm in Exhibit 21 -2 should produce a. A units b. B units c. C units d. more than C units C. C units is the where MR = MC. 37

35. The profit maximizing firm in Exhibit 21 -2 a. has economic profit per unit equal to the distance UX b. has economic profit per unit equal to the distance SX c. has economic loss per unit equal to the distance SX d. none of these D. At the level of output where MR = MC this firm is making neither a profit or a loss but is making a normal profit (AR = AC). 38

36. The profit maximizing firm in Exhibit 21 -2 is a. earning an economic profit b. incurring an economic loss c. breaking even C. Breaking even means that it is making a normal profit. 39

P Last slide viewed MC M $366 $293 $180 $150 D =MR =AR 25 Exhibit 21 -3 ATC AVC 40 45 Q 40

37. The profit maximizing firm in Exhibit 21 -3 a. should produce 45 units of output b. should produce 40 units of output c. should produce 25 units of output d. would minimize losses by closing A. 45 units of output is the level of output where MR = MC. 41

38. The profit maximizing firm in Exhibit 21 -3 a. breaks even b. should produce slightly less than 40 units of output c. has fixed costs of $5400 d. should close immediately to minimize losses C. At the level of output where MR = MC average total cost (ATC) is $300 and average variable cost (AVC) is $180 so average fixed cost (AFC) is $300 minus $180 or $120; total fixed cost, therefore, is $120 x 45 or $5, 400. 42

39. The profit maximizing firm in Exhibit 21 -3 is a. earning a profit per unit of $66 b. earning a profit per unit of $73 c. earning a profit per unit of $186 d. earning a profit per unit of $216 A. Profit per unit is equal to AR minus ATC at the level of output where MR = MC. In this case AR is $366 and ATC is $300, so profit per unit (on the average) is $366 minus $300 or $66. 43

40. The maximum total profit the firm could earn in Exhibit 21 -3 a. would be negative since the firm has an economic loss b. is $2970 c. is $5400 d. is $8370 B. Because this firm is making an average profit of $66 at the level of output where MR = MC and the number of units at the level of output where MR = MC is 45 units, total profit is 45 x $66 or $2970. 44

41. At the profit maximizing output, the firm in Exhibit 21 -3 has a. average total cost of $150 b. a total cost of $13, 500 c. a total variable cost of $3750 d. a total cost of $9150 B. Average total cost (ATC) at 45 units is $300, so total cost (TC) at 45 units is 45 x $300 or $13, 500. 45

42. The firm illustrated in Exhibit 21 -3 a. is both d and e b. has all of the following characteristics c. earns an economic profit d. is perfectly competitive e. is a price taker B. It is earning an economic profit because AR is greater than AC at the level of output where MR = MC. This has to be a perfectly competitive firm because D = AR = MR. Any firm that is a part of a perfectly competitive industry is a price taker because it has no incentive to charge a price other than the market price. 46

43. The perfectly competitive firm in Exhibit 21 -3 would find it in its best interest to stop producing immediately if the market’s equilibrium price falls below a. $293 b. $180 c. $150 d. $366 C. If the market price were to fall below $150 (where MC intersect AVC) its losses would exceed its fixed cost and therefore should close down. 47

44. How will a decrease in the equilibrium price in the market of a perfectly competitive industry affect the total revenue and the economic profit of a typical firm? a. both total revenue and economic profit will decrease at all rates of output b. total revenue and economic profit may increase or decrease, although they will be directly related to each other c. it is impossible to predict A. Because total revenue (TR) equals price (P) times quantity (Q), when price declines, TR declines. Economic profit (profit) is average revenue (AR) minus average total cost (ATC), so when AR declines, so does profit. 48

45. A decrease in market price in a perfectly competitive industry a. does not affect the total revenue curve of the typical firm b. shifts the total revenue curve of the typical firm to the left, without changing its slope c. shifts the total revenue curve of the typical firm to the right, without changing its slope d. reduces the slope of the total revenue curve of the typical firm D. Reducing the slope means that the curve becomes more horizontal (elastic). As the market price decreases less revenue (measured on the vertical axis) is added to TR. 49

46. Which is true with regard to the shutdown point and the break-even point for a perfectly competitive firm? a. they are two names for the same point b. the shutdown point is minimum average variable cost and the break-even point is minimum average total cost c. the shutdown point is minimum average total cost and the break-even point is minimum average variable cost d. the shutdown point is minimum average variable cost and the break-even point is minimum average fixed cost B. 50

47. The perfectly competitive firm’s short-run supply curve is the same as the a. supply curve of all other firms in the industry b. upward-sloping portion of its MR curve c. upward-sloping portion of its marginal cost curve at or above the minimum AVC curve C. A supply curve shows how many units will be supplied at various prices. Because a firm will produce where MR = MC, the intersection of MR and MC shows us how many units will be supplied at various prices. Below the AVC curve a firm will shut down, therefore, the supply curve is irrelevant below this point. 51

48. In a Dutch auction, a. bidding starts a a high price and decreases until a buyer stops the clock b. bidding starts at a low price and increases until only one buyer remains c. bidding is done in sealed envelopes, with the high bid winning d. any buyer or seller may announce a bid or an offer to the entire market at any time A. Interesting! 52

49. Positive short-run economic profit a. may occur even if accounting profit is negative b. attracts resources into an industry c. creates incentives for resources to leave an industry d. can never occur in perfect competition B. The lower are the barriers to entry, the more likely that firms will enter into the industry to partake in the economic profits being made. 53

50. Which characteristic of perfect competition ensures that economic profit will be zero in the long run? a. each firm’s output is small in relation to total market supply b. the product is homogeneous c. there is freedom of entry and exit in the market C. In a perfectly competitive industry there almost no barriers to entry or exit. Therefore, when a profit is made, firms will easily enter the industry. Likewise, when losses are made, some firms will easily leave the industry. 54

51. Which of the following is not a condition of long-run equilibrium for perfectly competitive firms? a. price is equal to marginal cost b. price is equal to minimum short-run average total cost c. price is equal to minimum long-run average cost d. economic profit is positive D. In long-run equilibrium, a firm in a perfectly competitive industry will make a normal profit (zero economic profit). 55

52. Consider a perfectly-competitive, constantcost industry in long-run equilibrium which experiences a decrease in demand. What happens after long-run adjustments? a. price and output both remain unchanged, although profit has decreased b. price has fallen and profit is lower, but output remains unchanged c. price and profit ultimately remain unchanged, but market output has been reduced by some firms leaving the industry C. A constant cost industry is one that can expand or contract without effecting the longrun per-unit cost of production; the long-run industry supply curve is horizontal. 56

53. Consider a perfectly-competitive, decreasingcost industry in long-run equilibrium which experiences a decrease in demand. What happens after long-run adjustments? a. profits has decrease b. price has risen and output has been reduced by some firms leaving the industry, but profit ultimately remains unchanged c. in the long run, there would be no changes in price, output, or profit B. A decreasing cost industry is the rare case in which an industry faces lower per-unit production costs as industry output expands in the long run; the long-run industry supply curve slopes downward. 57

54. Consider a perfectly competitive market in long-run equilibrium. What adjustments take place during the short-run when there is a decrease in market demand? a. price and output remain unchanged, although profit decreases b. price and profit fall, but output remains unchanged c. price and profit fall, and firms reduce output by using existing capacity less intensively C. The short-run is a period of time that a firms can change output but cannot change their capacity to produce. The long-run is a period of time which firms can change their plant capacity. 58

55. The long-run industry supply curve in a perfectly competitive market a. is the horizontal sum of each firm’s shortrun supply curves b. illustrates what happens to average costs as industry output increases c. illustrates what happens to average costs as a firm increases its output A. Theoretically, if we can determine the supply curve for each firm in the industry, and then add the curves horizontally, the result would be the industry’s supply curve. 59

56. A constant-cost industry is distinguished by the fact that a. firms’ long-run average cost curve are horizontal b. firms’ short-run marginal cost curves are horizontal c. firms’ short-run average total cost curves are horizontal d. the long-run industry supply curve is perfectly elastic D. Perfectly elastic means perfectly horizontal. In this case, the firm can change output without effecting costs. 60

57. If an increase in industry output pushes resource prices higher, then a. it is an increasing-cost industry b. firms’ long-run average cost curves are upward-sloping c. firms’ short-run marginal cost curves are upward-sloping d. firms’ short-run average total cost curves are upward-sloping A. The supply curve in an increasing-cost industry is less elastic (more horizontal) then is the case in a constant-cost industry. In this case, as industry output increases, per unit costs will increase. 61

58. Decreasing-cost industries a. are the most common industry type in the real world b. occur only when costs are independent of the number of firms in the market c. occur when average costs increase as the number of firms increases d. occur when average costs decrease as the number of firms increases D. This is a rare case. Supply curves are almost always upward sloping (they have a positive slope). But in this case, the long-run industry supply curve is downward sloping (it has a negative slope). 62

59. The choice of which goods to produce, and how to distribute these goods, falls under the concept of a. technological efficiency b. productive efficiency c. allocative efficiency d. economic efficiency C. A basic question for any economic system is “how do we allocate society’s scarce resources? ” 63

60. Productive efficiency involves a. producing and selling the most output possible b. maximizing the price of the product c. producing and selling output for the greatest possible total revenue d. producing at the lowest possible cost per unit of output D. Once society decides what to produce, it has to determine how to produce goods and services the most efficient way possible. 64

61. When market exchange occurs voluntarily in a perfectly competitive market, a. the choice incurs no opportunity cost b. the combination of consumer surplus and producer surplus is maximized c. both consumer surplus and producer surplus are eliminated d. buyers benefit at the expense of producers B. Consumer surplus is the difference between the maximum amount that a consumer is willing to pay for a given quantity of a good and what the consumer actually pays. Producer surplus is the amount by which total revenue from production exceeds total variable cost. 65

62. Short-run producer surplus in competitive markets is a. total revenue minus total cost b. total revenue minus total variable cost c. total revenue minus total fixed cost d. price minus average total cost B. When total revenue minus total variable cost results in producer surplus, a firm is meeting at least all of its fixed costs and some (if not all) of its variable costs. Therefore, even if the firm were making a loss, its loss would be less than its fixed cost and it would continue to operate. 66

63. The definition of producer surplus ignores a. the price of the product b. the quantity of the product sold c. price elasticity of surplus d. sunk costs D. A sunk cost (fixed cost) is a cost that has to be paid no matter what; hence a cost that is irrelevant when an economic choice is being made. 67

64. In long-run equilibrium in perfect competition, producer surplus is a. often negative b. always positive c. always greater than consumer surplus d. smaller than in the short run D. If producer surplus is defined narrowly as total revenue minus total variable cost, producer surplus in the long run for perfectly competitive industries is zero. In long run equilibrium, all costs are variable and total cost equals total revenue, so there is no (zero) producer surplus. 68

65. Posted-offer pricing a. is rarely, if ever, seen in U. S. retail markets b. adjusts to changing market conditions more quickly and efficiently than does a double continuous auction c. is another name for a double continuous auction d. involves low transaction costs in large, stable markets D. In most U. S. retail markets, such as supermarkets and department stores, use posted-offer pricing - that is, the price is marked, not negotiated. 69

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