Foundations of Economics, 3e (Bade/Parkin) - Testbank 3
Chapter 13 Perfect Competition
1) Is the number of sellers in the market the only thing that is different in each of the four market types
economists study?
Answer: No, the number of sellers is not the only factor that differs; the degree of similarity of each firm's
product also plays a role. For instance, in a perfectly competitive market, each firm sells an identical
product whereas in a monopolistically competitive market, each firm sells a slightly different product.
Topic: Market types
Skill: Level 1: Definition
Objective: Checkpoint 13.1
Author: TS
2) Why do you never see firms in a perfectly competitive market advertise their product?
Answer: Advertising has costs and benefits for the typical firm. The cost is the expense of running the
advertising and the forgone value of the next best use of the firm's funds. The benefit of advertising is
the increased probability that the firm can increase the demand for its good or service. Therein lies the
problem for perfectly competitive firms. Perfectly competitive firms sell an identical product. Who is
going to believe an asparagus farmer in California that runs a television ad proclaiming that her
asparagus is better than other farmers? If demand is not increased by the ad, which is likely, the only
thing that is certain is that the farmer's costs have increased. Along with the higher costs comes
decreased profit and an increased likelihood of going out of business.
Topic: Market types
Skill: Level 5: Critical thinking
Objective: Checkpoint 13.1
Author: JC
3) What are the four types of markets? Give a brief description of each type.
Answer: The four types of markets are perfect competition, monopoly, monopolistic competition, and
oligopoly.
∙
Perfect competition has many firms selling identical products to many buyers, with no barriers to
entry or exit.
∙
Monopoly has one firm selling a good with no close substitutes and a barrier that blocks the entry
of new firms.
∙
Monopolistic competition has many firms making similar but not identical products with no
barriers to entry or exit.
∙
Oligopoly has a small number of generally large firms producing either identical or differentiated
products.
Topic: Market types
Skill: Level 1: Definition
Objective: Checkpoint 13.1
Author: SB
4) What four conditions define a perfectly competitive market?
Answer: The four conditions are that:
a. many firms sell an identical product to many buyers.
b. there are no restrictions on entry into (or exit from) the market.
c. established firms have no advantage over new firms.
d. sellers and buyers are well informed about prices.
Topic: Perfect competition
Skill: Level 1: Definition
Objective: Checkpoint 13.1
Author: SA
5) "Perfectly competitive firms have total control over the price they set for their product." Explain why the
previous statement is correct or incorrect.
Answer: The statement is incorrect. Perfectly competitive firms are price takers, which means that they have no
control over the price of their product. They must "take" the price given to them by the market as a
whole, that is, they must take the price determined by the market demand and market supply.
Topic: Price taker
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: SB
6) Does a perfectly competitive producer have any incentive to undercut the current market price? Explain your
answer
Answer: A perfectly competitive producer has no incentive to undercut the market price because the producer
can sell all he or she produces at the going market price. In this case, a producer will not lower the
price he or she charges because no additional sales can be garnered. Hence it is nonsensical to
undercut the market price because the lower price means lower revenue and hence lower profit.
Topic: Price taker
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: TS
7) Why are perfectly competitive ranchers in Montana price takers?
Answer: Because one farmer's beef is identical to another farmer's, each farmer's beef is a perfect substitute for
all other farmers' beef. In addition, there are over one million ranchers in the United States. As a result,
no individual rancher can impact the market price by increasing or decreasing production. Therefore
each rancher faces a perfectly elastic demand. Each can sell all of the beef desired at the market price,
but not one penny more. Once the market sets the price, the rancher must take as given whatever the
price might be.
Topic: Price taker
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: JC
8) "A perfectly competitive firm is called a price maker because all the firms together must make the market
price." Is the previous statement correct or incorrect? Briefly explain your answer.
Answer: The statement is false. A perfectly competitive firm is called a "price taker" because the firm must take
whatever price the market determines. Any single firm's actions cannot affect the market price.
Topic: Price taker
Skill: Level 1: Definition
Objective: Checkpoint 13.1
Author: WM
9) If a perfectly competitive firm manufacturing chairs produces 100 more chairs, what happens to the market
price of a chair?
Answer: The price will not change. Any one perfectly competitive firm is such a small part of the market that a
change in its output has virtually no effect on the price. This result is why the firm's marginal revenue
equals its price: No matter how much (or how little) the firm produces, the marginal revenue from one
more unit always equals the price of the product.
Topic: Price taker
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: SA
10) Pineapple growing is a perfectly competitive industry. How does the market demand curve for pineapples
compare to the demand curve for an individual pineapple grower?
Answer: The market demand curve for pineapples is downward sloping. The demand curve for an individual
pineapple grower is a horizontal line. In other words, the demand faced by an individual grower is
perfectly elastic whereas the market demand is not perfectly elastic.
Topic: Demand
Skill: Level 1: Definition
Objective: Checkpoint 13.1
Author: JC
11) What is the shape of the demand curve faced by the perfectly competitive firm, and why?
Answer: The demand curve faced by a perfectly competitive firm is horizontal, that is, the demand is perfectly
elastic. A perfectly competitive firm is one of many sellers in the market that produce identical
products. A single firm's output is small relative to the market demand so the firm cannot influence
the market price by increasing or decreasing its output. It can sell any quantity it chooses at the going
price. Hence the firm's demand curve is a horizontal line at the market price.
Topic: Demand
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: SA
12) Why does the profit-maximizing level of production occur at the point where marginal revenue equals
marginal cost?
Answer: If a firm produces at a level where marginal revenue is greater than marginal cost, more profit could
be gained by increasing output. Why? Because the added revenue (the marginal revenue) from
producing another unit exceeds the added cost (the marginal cost) of producing the unit. Therefore the
firm should increase production until no more additional profit can be earned, which occurs where
marginal revenue equals marginal cost.
Similarly, if a firm produces at a level where marginal cost exceeds marginal revenue, the
firm's profit would rise by decreasing output. In this case, the saved costs (the marginal cost) exceed
the lost revenue (the marginal revenue). Therefore the firm should decrease production until the point
at which marginal cost equals marginal revenue.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: JC
13) If the market price faced by a perfectly competitive firm increases, in the short run how does the firm
respond?
Answer: If the market price rises, a perfectly competitive firm increases its output. Essentially the firm moves
upward along its marginal cost curve, thereby increasing the quantity the firm will supply.
Topic: Firm's short-run supply curve
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: SA
14) What is a perfectly competitive firm's short-run supply curve?
Answer: A perfectly competitive firm's short-run supply curve is its marginal cost curve above the minimum
average variable cost.
Topic: Firm's short-run supply curve
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: MR
15) If the price received by a perfectly competitive firm is less than its average variable cost, what will the firm
do in the short run? Why?
Answer: If the price is less than the average variable cost, the firm will shut down in the short run. By shutting
down, the firm will incur an economic loss equal to its fixed cost. Whereas if the firm operated, its
economic loss would be larger. Therefore the firm minimizes its loss by shutting down.
Topic: Shut down
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: SA
16) Will a perfectly competitive firm ever produce in the short run even though it is suffering an economic loss?
Answer: Yes, a perfectly competitive firm will continue to produce even though it is suffering an economic loss
if the price exceeds the minimum average variable cost. In this case, even though the firm has an
economic loss, if it shut down, its economic loss would be larger.
Topic: Shut down
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: PH
17) What must be the case if a perfectly competitive firm's economic loss is less by shutting down rather than by
producing and selling some output?
Answer: If a firm's economic loss is greater when it produces and sells some output than when it shuts down, it
is the case that the price of the product is less than the average variable cost. When the price is less
than the average variable cost, the firm's economic loss is less if it shuts down than if it produces and
sells output.
Topic: Shut down
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: SB
18) Pete is a perfectly competitive rose grower. The above table gives quantities and the price for which Pete can
sell his roses.
a. What is Pete's total revenue if he sells 1 dozen roses? 2 dozen roses? 3 dozen roses? 4 dozen roses?
b. What is the marginal revenue of the 2nd dozen roses sold? Of the 3rd dozen? Of the 4th dozen?
Answer: a. The total revenue when 1 dozen roses is sold is $12. When Pete sells 2 dozen roses, the total
revenue is $24. When 3 dozen roses are sold, the total revenue is $36. And the total revenue when 4
dozen roses are sold is $48.
b. The marginal revenue is always $12 per dozen roses.
Topic: Total revenue, marginal revenue
Skill: Level 2: Using definitions
Objective: Checkpoint 13.1
Author: WM
19) Farmer Brown produces corn in a perfectly competitive market. Farmer Brown produces and sells 500
bushels of corn. The market supply and demand curves are illustrated in the above figure.
a. What is Farmer Brown's total revenue?
b. What is Farmer Brown's marginal revenue?
Answer: a. Total revenue = price × quantity. The price is determined by the intersection of the demand and
supply curves, $6 a bushel. As a result, Farmer Brown's total revenue is $6 × 500 = $3,000.
b. For a perfectly competitive firm, the marginal revenue equals the price, so Farmer Brown's
marginal revenue is $6.
Topic: Total revenue, marginal revenue
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: SB
20) The above table gives Amy's total cost schedule for producing holiday wreaths. Amy is a perfect competitor
and can sell each wreath for $9.
a. Complete the table by calculating Amy's total revenue and her profit or loss schedule.
b. When Amy is producing 4 wreaths, what is her total cost? What is her total revenue? What is her
economic profit or economic loss?
c. What number of wreaths maximizes Amy's profit?
Answer:
a. The completed table is above.
b. When Amy is producing 4 wreaths, her total cost is $28, her total revenue is $36, and her economic
profit is $8.
c. Amy can produce 6 or 7 wreaths, with a maximum economic profit of $14.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: SB
21) Jimmy grows corn. His total revenue and total cost are in the above table. What quantity of corn maximizes
his profit and what is his profit? What is the marginal revenue and marginal cost at this quantity?
Answer: Jimmy's profit is greatest if he grows either 40,000 or 50,000 bushels of corn. His (economic) profit at
either amount is $10,000 a week. Between 40,000 and 50,000 bushels of corn, Jimmy's marginal revenue
is $30,000, or $3 per bushel and his marginal cost is $30,000, or $3 per bushel.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: WM
22) The above table gives the quantity of output and the total cost for a perfectly competitive firm that can sell all
of its output at $9 per unit.
a. Find the profit maximizing level of output for this firm.
b. How much economic profit is the firm making?
Answer:
a. Total revenue equals price times quantity sold. We can find the total revenue for this firm because
the market price is a constant $9. The total revenue schedule is given in the table above. The total
profit (or loss) equals total revenue minus total cost. The last column shows that the total profit is
largest if either 2 or 3 units are produced.
b. When the firm produces either 2 or 3 units of output, the total economic profit is $6.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: SA
23) The above table shows the total cost schedule for a perfectly competitive firm. The market price is $250 per
unit. Complete the table.
Answer:
The completed table is above.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: PH
24) Acme is a perfectly competitive firm. It has the total cost schedule given in the above table. Acme's product
sells for $8.00 per unit. What amount of output is the most profitable and what is Acme's economic profit or
economic loss?
Answer: Acme's profit-maximizing level of output is 7 units. Acme's total economic profit equals its revenue,
$56.00 ($8.00 per unit × 7 units), minus its total cost, $49.80 at this level of output, or $56.00 - $49.80 =
$6.20.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: TS
25) Acme is a perfectly competitive firm. It has the cost schedules given in the above table and has a fixed cost of
$12.00. The price of Acme's product is $14.20. What is Acme's most profitable amount of output? What is
Acme's total economic profit or loss?
Answer: The profit maximizing level of output is either 7 or 8 units. Acme's total economic profit is the
economic profit per unit times the number of units produced. The economic profit per unit equals the
price minus the average total cost. To calculate average total cost, note that when Acme produces 8
units, the average variable cost per unit is $6.50 and the average fixed cost is $1.50, so Acme's average
total cost equals $8.00. Thus Acme makes an economic profit of $14.20 - $8.00 = $6.20 per unit. Hence
Acme's total economic profit is ($6.20) × (8 units) = $49.60. Acme's total economic profit when it makes
7 units is (except for rounding) identical.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: TS
26) Acme is a perfectly competitive firm. It has the cost schedules given in the above table and has a fixed cost of
$12.00. The price of Acme's product is $4.00. What is Acme's most profitable amount of output? What is
Acme's total economic profit or loss?
Answer: Acme's most profitable (which means, in this case, minimum loss) is output of 0 units. The price is
below Acme's minimum average variable cost, so Acme shuts down. Acme's economic loss equals its
fixed costs, $12.00.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: TS
27) The above figure illustrates a perfectly competitive wheat farmer.
a. What will be the firm's profit-maximizing price and output?
b. When the farmer produces 25,000 bushels of wheat, the difference between the firm's average total cost
and the price is at its maximum. Explain why this amount of wheat either is or is not the profit-maximizing
quantity.
Answer: a. The firm will maximize its profits by producing where its marginal revenue equals its marginal
cost, or 30,000 bushels of wheat. The price will equal the marginal revenue, $3.00 a bushel.
b. At 25,000 bushels, the difference between average cost and price (which is the average revenue) is
indeed at the maximum, but choosing 25,000 will maximize the profit per bushel of wheat, not the total
profit. The firm is interested in maximizing the total profit not the profit per bushel. At 30,000 bushels
of wheat, the total profit is maximized because this is the amount of output where the difference
between total revenue and total cost is at a maximum.
Topic: Profit maximization
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: SA
28) The above diagram shows the cost curves for a perfectly competitive wheat farmer. At what price does the
wheat farmer shut down?
Answer: The wheat farmer shuts down if the price is less than the minimum average variable cost. So in the
figure, the wheat farmer shuts down if the price is less than $2 per bushel.
Topic: Shut down point
Skill: Level 3: Using models
Objective: Checkpoint 13.1
Author: CD
29) Can a perfectly competitive firm earn an economic profit in the short run? Can it incur an economic loss?
Answer: In the short run, a perfectly competitive firm can earn an economic profit or incur an economic loss.
Indeed, the firm also can earn a normal profit in the short run. Basically, any profit or loss outcome is
possible in the short run.
Topic: Economic profit, economic loss
Skill: Level 2: Using definitions
Objective: Checkpoint 13.2
Author: SA
30) If the market price is less than a perfectly competitive firm's average total cost, what sort of profit or loss is
the firm earning?
Answer: If the price is less than the average total cost, the firm is incurring an economic loss.
Topic: Economic loss
Skill: Level 3: Using models
Objective: Checkpoint 13.2
Author: WM
31) What is the relationship between the price, P, and the average total cost, ATC, for a firm in perfect
competition that earns an economic profit? That earns a normal profit? That incurs an economic loss?
Answer: If the price is greater than the average total cost, P > ATC, the firm earns an economic profit. If the
price equals the average total cost, P = ATC, the firm earns a normal profit. If the price is less than the
average total cost, P < ATC, the firm incurs an economic loss.
Topic: Economic profit, economic loss
Skill: Level 2: Using definitions
Objective: Checkpoint 13.2
Author: MR
32) John keeps beehives and sells 100 quarts of honey per month. The honey market is perfectly competitive, and
the price of a quart of honey is $10. John has an average variable cost of $5 and an average fixed cost of $3. At
100 quarts per month, John's marginal cost is $10.
a. Is John maximizing his profit? If not, what should John do?
b. Calculate John's total revenue, total cost, and total economic profit or economic loss when he produces 100
quarts of honey.
Answer: a. Yes, John is maximizing his profit because marginal revenue (price) equals marginal cost.
b. Total revenue equals price times quantity = $10 × 100 = $1,000.Total cost equals average total cost
times quantity = ($5 + $3) × 100 = $800.Economic profit equals total revenue minus total cost = $1,000 $800 = $200.
Topic: Economic profit
Skill: Level 4: Applying models
Objective: Checkpoint 13.2
Author: SB
33) The above diagram shows the cost curves for a perfectly competitive wheat farmer. At what price(s) does the
wheat farmer earn an economic profit? Earn a normal profit? Incur an economic loss? How many bushels of
wheat does the farmer produce if the price is $3 per bushel? If the price is $0.50 per bushel?
Answer: At any price that exceeds the minimum of the average total cost the farmer earns an economic profit.
So the farmer earns an economic profit if the price is greater than $2 per bushel. The farmer earns a
normal profit if the price equals the minimum total cost. So the farmer earns a normal profit if the
price is $2 per bushel. Finally, the farmer incurs an economic loss if the price is less than the minimum
average total cost. So the farmer incurs an economic loss if the price is less than $2 per bushel.
If the price is $3 per bushel, the farmer produces 30,000 bushels of wheat per year. If the price
is $0.50 per bushel, the farmer has shut down because the price is less than the minimum average
variable cost and so the farmer produces 0 bushels per year.
Topic: Economic profit
Skill: Level 4: Applying models
Objective: Checkpoint 13.2
Author: CD
34) "For a perfectly competitive market, an economic profit attracts new firms. But when these firms enter the
market, the price falls and the economic profit is eliminated." Are the previous statements correct or
incorrect? What is the long-run profit or loss outcome for firms in a perfectly competitive market?
Answer: The statements are correct. As the statements point out, in the long run the economic profit of perfectly
competitive firms is eliminated by entry. Similarly, an economic loss will be eliminated by exit.
Therefore the long-run equilibrium profit for a perfectly competitive firm is a normal profit.
Topic: Entry
Skill: Level 2: Using definitions
Objective: Checkpoint 13.3
Author: SB
35) In the long run, perfectly competitive firms cannot earn an economic profit. Why?
Answer: An economic profit attracts entry by new firms. As new firms enter the market, the market supply
increases and the market supply curve shifts rightward. The increase in supply decreases the price.
And, as the price falls, the economic profit is eliminated.
Topic: Long-run equilibrium, entry
Skill: Level 2: Using definitions
Objective: Checkpoint 13.3
Author: SB
36) The U-pick berry market is perfectly competitive. Suppose that all U-pick blueberry farms have the same cost
curves and all are earning an economic profit. What happens as time passes? What is the long-run
equilibrium outcome?
Answer: The presence of economic profit attracts new firms into the U-pick blueberry market. As the new firms
(the new farmers) enter the market, the supply of U-pick blueberries increases. The increase in the
supply drives the price lower and decreases the economic profits of the existing farmers. New farmers
continue to enter the market as long as there is the possibility of an economic profit. Eventually
enough new firms enter so that the price is driven so low that the economic profit is eliminated. All the
firms earn a normal profit, which will keep them in business but will provide no incentive for new
firms to enter the market. At this point, the long-run equilibrium has been reached.
Topic: Long-run equilibrium, entry
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: WM
37) When will new firms enter a perfectly competitive market? When does entry stop?
Answer: New firms will enter a perfectly competitive market as long as the existing firms are earning an
economic profit. Essentially the new firms enter in order to earn an economic profit themselves. Entry
will stop when it is no longer possible to earn an economic profit, which occurs when the existing
firms are earning a normal profit.
Topic: Long-run equilibrium, entry
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: WM
38) Describe how economic losses are eliminated in a perfectly competitive industry.
Answer: If firms are making losses, some will exit in the long run. When firms exit, the market supply
decreases and the market supply curve shifts leftward. When supply decreases, the price rises. As the
price rises, the surviving firms increase production and their economic losses are eliminated.
Topic: Long-run equilibrium, exit
Skill: Level 2: Using definitions
Objective: Checkpoint 13.3
Author: SB
39) Pumpkin growing is a perfectly competitive industry. Suppose that pumpkin growers are all generally
suffering an economic loss. What happens as time passes? What is the long-run equilibrium outcome?
Answer: Because the firms are generally experiencing an economic loss, as time passes some firms will exit the
market, perhaps by switching to other crops, or perhaps by closing entirely. As farmers leave the
market, the supply of pumpkins decreases. The supply curve shifts leftward and the price of a
pumpkin rises. As the price rises, the economic losses of the remaining firms decrease. Eventually
enough farmers leave the market so that the price rises sufficiently so that the remaining firms earn a
normal profit and no longer suffer an economic loss. At that point, the long-run equilibrium is reached
because there is no further incentive for any firms to leave the market.
Topic: Long-run equilibrium, exit
Skill: Level 4: Applying models
Objective: Checkpoint 13.3
Author: WM
40) Suppose a farmer raising beef is earning a normal profit. Then, because of a scare about mad cow disease, the
demand for beef decreases drastically. What happens to the profits of the beef farmer in the short run and in
the long run?
Answer: In the short run, the fall in beef prices will decrease the farmer's profits. With the fall in price, the
farmer will incur an economic loss. If the price is high enough so the revenue covers the farmer's
variable costs, the farmer will continue to operate. In the long run, if demand continues to remain
depressed, some farmers will exit the market until the remaining farmers earn a normal profit once
again.
Topic: Long-run equilibrium, exit
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: SA
41) How does a decrease in the demand for wheat ultimately lead to normal profits for wheat growers in the
long run?
Answer: If the demand for wheat decreases, the price of wheat falls and many wheat farmers incur economic
losses. These losses lead to some farmers shutting down their operations. As these farmers exit the
market, the supply of wheat decreases. A decrease in the supply of wheat pushes wheat prices back
up. The process of exit and rising prices continues until finally the price of wheat rises enough so that
the surviving wheat farmers are earning a normal profit. At this time, which occurs in the long run,
the economic losses have disappeared and no further exit occurs. The wheat market is back in its longrun equilibrium.
Topic: Long-run equilibrium, exit
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: JC
42) Entry by competitive firms decreases the market price, while exit by competitive firms increases the market
price. Explain why firms enter or exit an industry and why these price changes occur.
Answer: Competitive firms will enter an industry where economic profits exist in an attempt to earn an
economic profit. As new firms enter, the supply increases and the supply curve for the product shifts
rightward. The increase in supply drives the price lower. Firms exit an industry when economic losses
are incurred. As they leave, supply decreases and the supply curve shifts leftward. The decrease in the
supply forces the price higher. Entry and exit continue until the remaining firms in the industry are
earning a normal profit.
Topic: Long-run equilibrium, entry and exit
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: PH
43) In the long run, a perfectly competitive firm earns zero economic profit. What incentive does the firm have to
stay in business if it is making zero economic profit?
Answer: Zero economic profits do not mean no profit whatsoever. The firm is still making a normal profit. A
normal profit compensates the firm's owners enough to keep the firm in business because it is equal to
the owner's opportunity cost. Hence the firm has the incentive to stay in business.
Topic: Long-run equilibrium
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: SA
44) With regard to its profits and losses, how is the short run different from the long run for a perfectly
competitive firm?
Answer: The firm can earn an economic profit, incur an economic loss in the short run, or earn a normal profit
in the short run. In the long run, however, the only possible outcome is a normal profit. An economic
profit attracts entry by new firms and economic losses lead to exit by some firms. Thus, after entry or
exit is complete in the long run, the remaining firms will earn a normal profit.
Topic: Long-run equilibrium
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: SA
45) During the middle of the 1990s, the price of pork rose. After a couple of years the price decreased back to
about the level before the initial increase. What might have led to these events?
Answer: There are thousands upon thousands of hog farmers in the United States. In the middle of the 1990s, a
general decrease in the demand for beef led to a large increase in the demand for pork (the "other
white meat"). As a result of the increase in market demand, the price of pork increased dramatically.
Hog farmers were getting a high price and earning large economic profits.
In the long run, unable to prevent the flow of information to prospective hog farmers, the word
got out that economic profit was possible in this arena. Over time, more hog farmers entered the
market, which led to a large increase in the supply of pork. As supply increased, the price of pork
dropped.
Thus the higher price was the short-run result of an increase in demand. The falling price reflected
the adjustment to the long-run equilibrium, as new hog farmers entered the market. The long run was
ultimately reached and the price of pork was more or less the same as before the increase in demand.
Topic: Long-run equilibrium
Skill: Level 5: Critical thinking
Objective: Checkpoint 13.3
Author: JC
46) The above figure shows the cost curves of a profit-maximizing perfectly competitive firm. If the price equals
$7,
a. how much will the firm produce?
b. how much is the firm's average total, average variable, and marginal costs?
c. how much is the firm's total, total variable, and total fixed costs?
d. how much is the firm's total revenue and economic profit?
e. what will happen in this market in the long run?
Answer: a. The firm will produce 40 units of output because that is where the marginal revenue equals the
marginal cost.
b. The firm's average total cost equals $4, its average variable cost equals $3, and its marginal cost
equals $7.
c. The firm's total cost is $160 (= $4 × 40), its total variable cost is $120 (= $3 × 40), and its total fixed
cost is $40 (= $160 - $120).
d. The firm's total revenue is $280 (= $7 × 40) and its economic profit is $120 (= $280 - $160).
e. In the long run, firms will enter the market in response to the economic profit. The market supply
curve will shift rightward, the price will fall, and the economic profit will be eliminated.
Topic: Long-run equilibrium, entry
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: SB
47) American restaurants receive their supply of baby back-ribs from American farms and from farms in
Denmark. In the figures above, the left diagram shows the perfectly competitive market for baby back ribs in
the United States. The right figure shows the situation at Premium Standard Farm in Kansas, one of the
many U.S. farms supplying these ribs.
Now assume that the United States imposes a ban on European meat in response to the foot-and-mouth
disease that has infected livestock in Europe. (Which the United States did in 2001.) In particular, suppose
that the U.S. ban decreases the supply by 40 tons a year. Using the figure on the left, show the impact of this
ban on the baby back rib market. Using the figure on the right, show the impact on Premium Standard Farm
in Kansas.
Answer:
The ban on European meat decreases the supply of baby back ribs and shifts the supply curve
leftward, as shown by the shift from S1 to S2. The price rises to $4 a pound. As the figure on the right
shows, the MR curve for the Premium Standard Farm will shift upward, from MR1 to MR2. As a
result, the farm increases its production to 40,000 pounds of ribs. Because the price exceeds the
average total cost, the Premium Standard Farm makes an economic profit.
Topic: Long-run equilibrium, exit
Skill: Level 3: Using models
Objective: Checkpoint 13.3
Author: SA
48) Suppose the bobby pin industry is perfectly competitive. The price of a packet of bobby pins is $2.00. Pins
and Needles, Inc. is a firm in this industry and is producing 1,000 packets of bobby pins per day at the point
where the MC = MR. The average cost of production at this output level is $1.50 per packet.
a. What is the marginal cost of the 1,000th packet?
b. Is this firm making an economic profit, a normal profit, or an economic loss? How much?
c. Is the firm in long-run equilibrium? Why or why not?
Answer: a. The price per packet is $2, which is also the Pins and Needle's marginal revenue. The marginal
cost of the 1,000th packet is equal to marginal revenue, so for Pins and Needles the marginal cost is $2
per packet.
b. The firm is making a $0.50 economic profit per unit (which equals the price minus the average
total cost). Because Pins and Needles produces 1,000 packets, its total economic profit is $500.
c. The firm is making an economic profit, so it is not in long-run equilibrium. In the long run, a
perfectly competitive firm cannot earn an economic profit. The only outcome possible in the long run
is a normal profit.
Topic: Long-run equilibrium
Skill: Level 4: Applying models
Objective: Checkpoint 13.3
Author: SA