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120. Susan quit her job as a teacher, which paid her $36,000 per year, in order to start her own catering business.
She spent $12,000 of her savings, which had been earning 10 percent interest per year, on equipment for her business. She also borrowed $12,000 from her bank at 10 percent interest, which she also spent on equipment. For the past several months she has spent $1,000 per month on ingredients and other variable costs. Also for the past several months she has taken in $3,500 in monthly revenue.
a. In the short run, Susan should shut down her business, and in the long run she should exit the
industry.
b. In the short run, Susan should continue to operate her business, but in the long run she should exit
the industry.
c. In the short run, Susan should continue to operate her business, but in the long run she will
probably face competition from newly entering firms.
d. In the short run, Susan should continue to operate her business, and she is also in long-run
equilibrium.
ANS: B DIF: LOC: Perfect competition 3 REF: 14-2 TOP: Losses NAT: Analytic MSC: Analytical
121. A firm in a competitive market has the following cost structure:
Output 0 1 2 3 4 5 Total Cost $5 $10 $12 $15 $24 $40 If the market price is $4, this firm will
a. produce two units in the short run and exit in the long run. b. produce three units in the short run and exit in the long run. c. produce four units in the short run and exit in the long run. d. shut down in the short run and exit in the long run.
ANS: B DIF: LOC: Perfect competition 3 REF: 14-2 TOP: Losses NAT: Analytic MSC: Applicative
122. Competitive firms that earn a loss in the short run should
a. shut down if P < AVC. b. raise their price. c. lower their output.
d. All of the above are correct.
ANS: A DIF: LOC: Perfect competition 1 REF: 14-2 TOP: Losses NAT: Analytic MSC: Interpretive
123. Mrs. Smith is operating a firm in a competitive market. The market price is $6.50. At her profit-maximizing
level of output, her average total cost of production is $7.00, and her average variable cost of production is $6.00. Which of the following statements about Mrs. Smith’s firm is correct? a. Mrs. Smith is earning a loss and should shut down in the short run.
b. Mrs. Smith is earning a loss but should continue to operate in the short run. c. Mrs. Smith is earning a profit since the price is above the average variable cost.
d. Without knowing Mrs. Smith's marginal cost, we cannot determine whether she should stay in
business or shut down.
ANS: B DIF: LOC: Perfect competition 2 REF: 14-2 TOP: Losses NAT: Analytic MSC: Applicative
Chapter 14/Firms in Competitive Markets ? 975
124. Suppose you value a special watch at $100. You purchase it for $75. On your way home from class one
day, you lose the watch. The store is still selling the same watch, but the price has risen to $85. What should you do?
a. Pay the $85 to buy the watch.
b. Wait to see if the watch goes on sale. If the price drops to $75 or less, buy the watch. c. Wait to see if the watch goes on sale. If the price drops to $25 or less, buy the watch. d. Do not buy the watch.
ANS: A DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Sunk costs NAT: Analytic MSC: Interpretive
125. When fixed costs are ignored because they are irrelevant to a business's production decision, they are called
a. explicit costs. b. implicit costs. c. sunk costs.
d. opportunity costs.
ANS: C DIF: LOC: Perfect competition 1 REF: 14-2
TOP: Sunk costs NAT: Analytic MSC: Interpretive
126. When a profit-maximizing firm's fixed costs are considered sunk in the short run, then the firm
a. can set price above marginal cost. b. must set price below average total cost. c. will never show losses.
d. can safely ignore fixed costs when deciding how much output to produce.
ANS: D DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Sunk costs NAT: Analytic MSC: Interpretive
127. Which of these types of costs can be ignored when an individual or a firm is making decisions?
a. sunk costs b. marginal costs c. variable costs d. opportunity costs
ANS: A DIF: LOC: Perfect competition 1 REF: 14-2
TOP: Sunk costs NAT: Analytic MSC: Interpretive
128. Suppose you bought a ticket to a football game for $30 and that you place a $35 value on seeing the game. If
you lose the ticket, then what is the maximum price you should pay for another ticket? a. $5 b. $30 c. $35 d. $65
ANS: C DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Sunk costs NAT: Analytic MSC: Interpretive
129. You purchase a $30, nonrefundable ticket to a play at a local theater. Ten minutes into the show you realize
that it is not a very good show and place only a $10 value on seeing the remainder of the show. Alternatively you could leave the theater and go home and watch TV or read a book. You place an $8 value on watching TV and a $6 value on reading a book.
a. You should leave the theater since the net benefit from seeing the remainder of the show is -$20,
while going home will earn you at least $8 of satisfaction. b. You should stay and watch the remainder of the show. c. You should go home and watch TV. d. You should go home and read a book.
ANS: B DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Sunk costs NAT: Analytic MSC: Applicative
976 ? Chapter 14/Firms in Competitive Markets
130. You purchase a $30, nonrefundable ticket to a play at a local theater. Ten minutes into the show you realize
that it is not a very good show and place only a $10 value on seeing the remainder of the show. Alternatively you could leave the theater and go home and watch TV or read a book. You place an $8 value on watching TV and a $12 value on reading a book.
a. You should stay and watch the remainder of the show. b. You should go home and watch TV. c. You should go home and read a book.
d. You should go home and either watch TV or read a book.
ANS: C DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Sunk costs NAT: Analytic MSC: Applicative
131. A sunk cost is one that
a. changes as the level of output changes in the short run.
b. was paid in the past and will not change regardless of the present decision. c. should determine the rational course of action in the future. d. has the most impact on profit-making decisions.
ANS: B DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Sunk costs NAT: Analytic MSC: Definitional
132. When economists refer to a production cost that has already been committed and cannot be recovered, they
use the term a. implicit cost. b. explicit cost. c. variable cost. d. sunk cost.
ANS: D DIF: LOC: Perfect competition 1 REF: 14-2
TOP: Sunk costs NAT: Analytic MSC: Definitional
133. A corporation has been steadily losing money on one of its product lines, Wally’s Widgets. The firm produces
Wally’s Widgets in a factory that cost $20 million to build 10 years ago. The firm is now considering an offer to buy that factory for $15 million. Which of the following statements about the decision to sell or not to sell is correct?
a. The firm should turn down the purchase offer because the factory cost more than $15 million to
build.
b. The $20 million spent on the factory is a sunk cost; that cost should not affect the decision.
c. The $20 million spent on the factory is an implicit cost, which should be included in the decision. d. The firm should sell the factory only if it can reduce its costs elsewhere by $5 million.
ANS: B DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Sunk costs NAT: Analytic MSC: Analytical
134. If a firm operating in a competitive industry shuts down in the short run, it can avoid paying
a. fixed costs. b. variable costs. c. total costs.
d. The firm must pay all its costs, even if it shuts down.
ANS: B DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
135. Bill operates a boat rental business in a competitive industry. He owns 10 boats and pays $1,000 per month
on the loan that he took out to buy them. He rents each boat for $200 per month. The variable cost for each boat rental is $50. In the off season, Bill should
a. operate his business as long as he rents at least 7 boats per month. b. operate his business as long as he rents at least 1 boat per month. c. operate his business as long as he rents all 10 boats each month. d. raise the price he charges per boat rental.
ANS: B DIF: LOC: Perfect competition 3 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
Chapter 14/Firms in Competitive Markets ? 977
136. When a perfectly competitive firm decides to shut down, it is most likely that
a. marginal cost is above average variable cost. b. marginal cost is above average total cost.
c. price is below the firm’s average variable cost. d. fixed costs exceed variable costs.
ANS: C DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
137. When total revenue is less than variable costs, a firm in a competitive market will
a. continue to operate as long as average revenue exceeds marginal cost. b. continue to operate as long as average revenue exceeds average fixed cost. c. shut down. d. raise its price.
ANS: C DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Analytical
138. When price is below average variable cost, a firm in a competitive market will
a. shut down and incur fixed costs.
b. shut down and incur both variable and fixed costs.
c. continue to operate as long as average revenue exceeds marginal cost. d. continue to operate as long as average revenue exceeds average fixed cost.
ANS: A DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
139. Which of the following statements best reflects the production decision of a profit-maximizing firm in a
competitive market when price falls below the minimum of average variable cost? a. The firm will continue to produce to attempt to pay fixed costs. b. The firm will immediately stop production to minimize its losses. c. The firm will stop production as soon as it is able to pay its sunk costs.
d. The firm will continue to produce in the short run but will likely exit the market in the long run.
ANS: B DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
140. A profit-maximizing firm will shut down in the short run when
a. price is less than average variable cost. b. price is less than average total cost.
c. average revenue is greater than marginal cost. d. average revenue is greater than average fixed cost.
ANS: A DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
141. In the long run, all of a firm's costs are variable. In this case the exit criterion for a profit-maximizing firm is to
shut down if
a. price is less than average total cost. b. price is greater than average total cost.
c. average revenue is greater than average fixed cost. d. average revenue is greater than marginal cost.
ANS: A DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
142. Which of the following statements is correct regarding a firm's decision-making?
a. The decision to shut down and the decision to exit are both short-run decisions. b. The decision to shut down and the decision to exit are both long-run decisions.
c. The decision to shut down is a short-run decision, whereas the decision to exit is a long-run
decision.
d. The decision to exit is a short-run decision, whereas the decision to shut down is a long-run
decision.
ANS: C DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
978 ? Chapter 14/Firms in Competitive Markets
143. A firm that shuts down temporarily has to pay
a. its variable costs but not its fixed costs. b. its fixed costs but not its variable costs. c. both its variable costs and its fixed costs. d. neither its variable costs nor its fixed costs.
ANS: B DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
144. A firm will shut down in the short run if the total revenue that it would get from producing and selling its
output is less than its a. opportunity costs. b. fixed costs. c. variable costs. d. total costs.
ANS: C DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
145. A firm will shut down in the short run if, for all positive levels of output,
a. its loss exceeds its fixed costs.
b. its total revenue is less than its variable costs.
c. the price of its product is less than its average variable cost. d. All of the above are correct.
ANS: D DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Interpretive
146. A firm's marginal cost has a minimum value of $2, its average variable cost has a minimum value of $4, and
its average total cost has a minimum value of $5. Then the firm will shut down if the price of its product falls below a. $2. b. $4. c. $5.
d. There is not enough information given to answer the question.
ANS: B DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Analytical
147. A firm's marginal cost has a minimum value of $50, its average variable cost has a minimum value of $80, and
its average total cost has a minimum value of $90. Then the firm will shut down if the price of its product falls below a. $90. b. $80. c. $50. d. $40.
ANS: B DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Analytical
148. Which of the following represents the firm's short-run condition for shutting down?
a. shut down if TR < TC b. shut down if TR < FC c. shut down if P < ATC d. shut down if TR < VC
ANS: D DIF: LOC: Perfect competition 2 REF: 14-2
TOP: Shut down NAT: Analytic MSC: Definitional