AP Economics:
Costs FRQ
November 2015
Perfect Competition FRQs
1. The table below gives the short-run total cost function for a typical firm in a perfectly
competitive industry.
Short-Run Total Cost Function
Quantity
Total Cost
Produced
(in dollars)
0
1
2
3
4
5
6
20
27
38
53
72
95
122
(a) What is the dollar value of the firm's total fixed cost? $20
(b) Calculate the marginal cost of producing the first unit of output. $7
(c) If the price the firm receives for its product is $20, indicate the firm's profit-maximizing
quantity of output and explain how you determined your answer. 4. This is highest
quantity where MR>MC…or could use direct calculation of TR>TC.
(d) Given your results in part (c), explain what will happen to the number of firms in the
industry in the long run. Will increase
(e) Assume that this firm operates in a constant-cost industry and has reached long-run
equilibrium. If the government imposes a per-unit tax of $2, indicate what will happen to the
firm's profit-maximizing output in the long run. No change in output
2. For each of the following statements, indicate whether it is true, false, or uncertain and
explain why.
(a) Average total cost is always greater than average variable cost by a constant amount.
False – the difference between ATC and AVC is AFC, which decreases as output increases
(the spreading effect)
(b) In the short run, a perfectly competitive firm always maximizes profit when average total
cost is at minimum. False – Profit Maximization is where MR=MC, which could be higher
or lower than the minimum of ATC
(c) If a firm shuts down in the short run, its profits will equal zero. False – it will continue to
absorb fixed costs.
3. Callahan's Orchard grows apples and operates in a constant-cost, perfectly competitive
apple industry. Callahan's Orchard is currently in long-run equilibrium.
(a) Draw correctly labeled side-by-side graphs for the apple market and Callahan's Orchard,
and show each of the following:
(i) Market output and price, labeled as "QM" and "PM", respectively
(ii)
Callahan's output and price, labeled as "QF" and "PF", respectively
PM and QM properly labeled
PM must = PF
PF must be tangent to minimum of ATC
QF is where MR = MC
(b) Now assume that the government provides farm support to apple growers by granting an
annual lump-sum subsidy to all apple growers. Indicate the effect the subsidy would have
on each of the following in the short run:
(i) Callahan's quantity of output. Explain. No impact on Callahan’s short-run output.
Lump-sum subsidy will not affect MC or MR
(ii) Callahan's profit increase
(iii) the number of firms in the industry no change in short run
(c)
Indicate how each of the following will change in the long run as a result of the lumpsum subsidy:
(i) The number of firms in the industry. Explain. Increase. Existence of economic profits
attracts new firms
(ii) Price will fall as supply curve shifts to the right
(iii) Industry output increases as supply curve shifts to the right
4. J & P Company operates in a perfectly competitive market for smoke alarms. J & P is
currently earning short-run positive economic profits.
(a) Using correctly labeled side-by-side graphs for the smoke alarm market and J & P
Company, indicate each of the following for both the market and the J & P Company:
(i) price
(ii) output
Market
J&P
Properly labeled market graph with downward-sloping D curve and upward-sloping S curve
Correct labeling of market equilibrium price and quantity
Horizontal firm D curve
Equilibrium quantity is where MR = MC
(b) In the graph in part (a) for J & P, indicate the area of economic profits that J & P Company
is earning in the short-run. Rectangle using P1, MC, ATC and Q1
(c) Using a new set of correctly labeled side-by-side graphs for the smoke alarm market and J
& P Company, show what will happen in the long run to each of the following:
(i) long-run equilibrium price and quantity in the market
(ii) long-run equilibrium price and quantity for J & P Company
Market
J&P
Show an increase in supply on market graph
Show both lower P and higher Q due to increase in supply
Show downward shift in D curve on firm graph
Firm Q where P = Minimum of ATC