Mr. Maurer
AP Economics
Name: ____________________________
Free Response Question (Long) – Perfect Competition
1. Yi Roses is a typical profit-maximizing company in a perfectly competitive industry that is in long-run
equilibrium.
a. At the bottom of this page, draw correctly labeled side-by-side graphs for the rose market and
for Yi Roses and show each of the following:
i. Price and output for the industry.
ii. Price and output for Yi Roses.
b. Assume that roses are a normal good and that consumer income falls. Assume that Yi Roses
continues to produce. On your graphs, show the effect of the decrease in consumer income on each of the
following in the short-run.
i. Price and output for the industry.
ii. Price and output for Yi Roses.
iii. Area of loss or profit for Yi Roses.
c. Following the decrease in consumer income, what must be true if Yi Roses is to continue to
produce in the short-run? The new price (P2) must be greater than AVC at the new quantity (Q3).
d. Assume that the industry adjusts to a new long-run equilibrium. Compare the following
between the initial and the new long-run equilibrium.
i. Price in the industry. Will return to the old equilibrium (Pe).
ii. Output for a typical firm. Will return to original quantity (Qe)
iii. The number of firms in the rose industry. There will be fewer firms in the industry due to the exit of
firms because of losses. Therefore, fewer firms will each produce the same quantity per firm, but the total
output for the industry will go down.
Yi Roses
Rose Industry
2003B Free Response Question (Long) –Perfect Competition/Monopoly
1. Market structures differ from one another in many respects. Consider two profit-maximizing
firms that each earn short-run economic profits. One is a perfectly competitive firm and the
other is a monopoly.
(a) For each firm, draw a correctly labeled graph showing the following:
(i) Price
(ii) Quantity of output
(iii) Area of economic profits
(b) For each firm, explain the relationship between price and marginal revenue. You
need to explain why price and marginal revenue are either the same or different for each type of
firm. For a perfectly competitive firm, price and marginal revenue are the same because it is a
price taker. It can sell as much of the good as it wants at the market price, so it does not have to
lower price to sell additional output. For a monopoly, marginal revenue is less than price because
the firm must lower price to sell additional output, but it must lower price on all units, not just
the additional unit in order to sell an additional unit, so it loses revenue on units at had been
selling at the old price. This means that marginal revenue will be less than price for the
monopoly.
(c) For each firm, explain how the economic profits would most likely change in the long
run. Again, explain how and why profits will or will not change in the long run for each firm.
For the perfectly competitive firm, profits will decrease until economic profits are zero. This is
because there are no barriers to entry in the industry, and new firms will enter the industry to
take advantage of the economic profits being earned. This will increase supply in the industry,
lowering price until economic profits are zero. Barriers to entry allow the monopolist to
continue making economic profits in the long run.
(d) Label the area that represents the deadweight loss on the graph for the monopoly firm
drawn in (a). Explain what this deadweight loss represents. In your answer, refer to the concepts
of socially optimal output, consumer and producer surplus, marginal cost, and price.
The triangular shaded region represents deadweight loss. This represents the loss of consumer
and producer surplus from producing at a quantity where price is greater than marginal cost,
which is less than the socially optimum output.
FRQ #4 (Long) Perfect Competition/Costs of Production
Umbrellas are produced by a perfectly competitive, constant-cost industry. In the short run, the
equilibrium price is $7 per umbrella and the typical firm is operating with a loss. The typical firm
has the total cost function shown in the table below.
Daily Output
0
1
2
3
4
5
6
Total Cost per Day
$10
$13
$18
$24
$32
$45
$60
(a) Using a correctly labeled graph, draw the demand curve for a typical firm in this
industry.
(b) Using the data above, determine each of the following for the typical firm.
(i) Total fixed cost $10
(ii) The loss-minimizing level of output 3 units
(iii) The value of losses at the output level you found in part (b)(ii) $3
(c) Explain why the typical firm chooses to operate despite incurring a loss in the short
run. Because price is greater than average variable cost, meaning it minimizes losses by
producing. If it is making enough revenue by producing to cover some of its fixed cost.
(d) If the total cost per day remains unchanged in the long run, what is the long-run
equilibrium price for umbrellas? $8 (that’s the minimum ATC from the chart).
Unit 3 – Firm Behavior and Market Structure – FRQ 2 (Short)
Costs of Production
1. Assume that a firm uses capital as a fixed factor of production and labor as a variable factor.
The marginal product of labor at first increases and then decreases with the amount of labor.
(a) Using a correctly labeled graph, draw and identify the firm’s average total cost curve
(ATC), average variable cost curve (AVC), and marginal cost curve (MC).
(b) Given your graph in part (a), answer each of the following.
(i) Why is the MC shaped as it is? Due to the law of diminishing returns.
Marginal product will increase as new units of labor are added at first, but eventually marginal
product will decrease, meaning that marginal cost will decrease at first, but eventually increase.
(ii) What does the difference between AVC and ATC represent?
Average fixed cost.
(c) Define economies of scale.
Economies of scale are decreasing long-run average total costs as output level is
increased.
(d) Draw a long run average total cost curve that has a region of economies of scale
followed by a region of diseconomies of scale, as output increases
(a)
(d)