934 ? Chapter 14/Firms in Competitive Markets
SHORT ANSWER1.
Describe the difference between average revenue and marginal revenue. Why are both of these revenue measures important to a profit-maximizing firm?ANS:
Average revenue is total revenue divided by the quantity of output. Marginal revenue is the change in total revenue from the sale of each additional unit of output. Marginal revenue is used to determine the profit-maximizing level of production, and average revenue is used to help determine the level of profits. Note that for all firms, price equals average revenue because AR=(PxQ)/Q=P. But only for a firm operating in a perfectly competitive industry does price also equal marginal revenue.
DIF: 2 TOP: Price REF: 14-1
MSC: Definitional
NAT: Analytic
LOC: Perfect competition
2. List and describe the characteristics of a perfectly competitive market.ANS:
There are many buyers and sellers in the market. The goods offered by the various sellers are largely the same. Firms can freely enter or exit the market.
DIF: 2 REF: 14-1 TOP: Competitive markets 3.
NAT: Analytic MSC: Definitional
LOC: Perfect competition
Why would a firm in a perfectly competitive market always choose to set its price equal to the current market price? If a firm set its price below the current market price, what effect would this have on the market?ANS:
The firm could not sell any more of its product at a lower price than it could sell at the market price. As a result, it would needlessly forgo revenue if it set a price below the market price. If the firm set a higher price, it would not sell anything at all because a competitive market has many sellers who would supply the product at the market price.
DIF: 2 REF: 14-1 TOP: Profit maximization 4.
NAT: Analytic
MSC: Analytical
LOC: Perfect competition
Use a graph to demonstrate the circumstances that would prevail in a competitive market where firms are earning economic profits. Can this scenario be maintained in the long run? Explain your answer.
ANS:
In a competitive market where firms are earning economic profits, new firms will have an incentive to enter the market. This entry will expand the number of firms, increase the quantity of the good supplied, and drive down prices and profits. Entry will cease once firms are producing the output level where price equals the minimum of the average total cost curve, meaning that each firm earns zero economic profits in the long run.
DIF: 2 REF: 14-2 TOP: Profit maximization NAT: Analytic
MSC: Analytical
LOC: Perfect competition
Chapter 14/Firms in Competitive Markets ? 935
5.
Explain how a firm in a competitive market identifies the profit-maximizing level of production. When should the firm raise production, and when should the firm lower production?
ANS:
The firm selects the level of output at which marginal revenue is equal to marginal cost. If MR > MC, profit will increase if the firm increases Q. If MR < MC, profit will increase if the firm decreases Q.
DIF: 2 REF: 14-2 TOP: Profit maximization 6.
NAT: Analytic
MSC: Analytical
LOC: Perfect competition
News reports from the western United States occasionally report incidents of cattle ranchers slaughtering a large number of newborn calves and burying them in mass graves rather than transporting them to markets. Assuming that this is rational behavior by profit-maximizing \influence such behavior.
ANS:
If the selling price is not sufficient to cover the variable cost of sending the calves to market, this (potentially emotionally upsetting) behavior makes economic sense.
DIF: 2 REF: 14-2 TOP: Profit maximization 7.
NAT: Analytic
MSC: Analytical
LOC: Perfect competition
Use a graph to demonstrate the circumstances that would prevail in a perfectly competitive market where
firms are experiencing economic losses. Identify costs, revenue, and the economic losses on your graph. Using your graph, determine whether an individual firm will shut down in the short run, or choose to remain in the market. Explain your answer.ANS:
The losses and revenues are identified on the individual firm's graph. Total cost is equal to the sum of the losses and revenue (because profit/loss=TR-TC, so TC=TR+profit/loss). The decision about whether this firm shuts down or remains in the market depends upon the position of average variable cost. If average variable cost is below P0 at output level Q0, the firm will remain in the market. If average variable cost is above P0 at output level Q0 the firm will shut down in the short run.
DIF: 2 REF: 14-2 TOP: Profit maximization 8.
NAT: Analytic
MSC: Analytical
LOC: Perfect competition
At its current level of production a profit-maximizing firm in a competitive market receives $12.50 for each unit it produces and faces an average total cost of $10. At the market price of $12.50 per unit, the firm's marginal cost curve crosses the marginal revenue curve at an output level of 1,000 units. What is the firm's current profit? What is likely to occur in this market and why?
ANS:
$2,500; firms are likely to enter this market since existing firms are earning economic profits.DIF: 2 TOP: Profit
REF: 14-2
MSC: Analytical
NAT: Analytic
LOC: Perfect competition
936 ? Chapter 14/Firms in Competitive Markets
9.
Give two reasons why the long-run industry supply curve may slope upward. Use an example to demonstrate your reasons.
ANS:
1) Some resource used in production may be available only in limited quantities. 2) Firms may have different cost structures. The example provided in the text for the first reason is the market for farm products. As more people become farmers, the price of land is bid up since its supply is limited. As the price of farm land is bid up, the costs to all farmers in the market rise. The example used to support the second reason is the market for painters. Anyone can enter the market for painting services, but not everyone has the same costs because some painters work faster than others.
DIF: 3
TOP: Supply curve REF: 14-3 NAT: Analytic
MSC: Interpretive
LOC: Perfect competition
10. If identical firms that remain in a competitive market over the long run make zero economic profit, why do
these firms choose to remain in the market?ANS:
Because a normal rate of return on their investment is included as part of the opportunity cost of production.
DIF: 2 REF: 14-3 TOP: Economic profit MSC: NAT: Analytic
Interpretive
LOC: Perfect competition
Sec00 - Firms in Competitive Markets
MULTIPLE CHOICE1.
A firm has market power if it can a. maximize profits. b. minimize costs.
c. influence the market price of the good it sells.
d. hire as many workers as it needs at the prevailing wage rate.
1
REF: 14-0 NAT: Analytic TOP: Market power
ANS: C DIF:
LOC: Perfect competition MSC: Definitional
2.
The analysis of competitive firms sheds light on the decisions that lie behind the a. demand curve. b. supply curve.
c. way firms make pricing decisions in the not-for-profit sector of the economy. d. way financial markets set interest rates.
1
REF: 14-0 NAT: Analytic TOP: Competitive market
ANS: B DIF:
LOC: Perfect competition MSC: Interpretive
3.
For any competitive market, the supply curve is closely related to the a. preferences of consumers who purchase products in that market. b. income tax rates of consumers in that market. c. firms’ costs of production in that market. d. interest rates on government bonds.
1
REF: 14-0 NAT: Analytic TOP: Competitive market
ANS: C DIF:
LOC: Perfect competition MSC: Interpretive
Chapter 14/Firms in Competitive Markets ? 937
4.
Suppose that firms in each of the two markets listed below were to increase their prices by 20 percent.
Which pair represents the example where customers would decrease their quantity purchased dramatically in one market and only slightly in the other market due to differences in market structure? a. corn and soybeans b. gasoline and restaurants c. water and cable television
d. spiral notebooks and college textbooks
2
REF: 14-0 NAT: Analytic TOP: Competitive market
ANS: D DIF:
LOC: Perfect competition MSC: Interpretive
Sec01 - Firms in Competitive Markets - What is a Competitive Market?
MULTIPLE CHOICE1.
A key characteristic of a competitive market is that a. government antitrust laws regulate competition. b. producers sell nearly identical products. c. firms minimize total costs. d. firms have price setting power.
1
REF: 14-1 NAT: Analytic TOP: Competitive markets
ANS: B DIF: LOC: Perfect competition MSC: Definitional
2.
Which of the following is not a characteristic of a competitive market? a. Buyers and sellers are price takers.
b. Each firm sells a virtually identical product. c. Free entry is limited.
d. Each firm chooses an output level that maximizes profits.
2
REF: 14-1 NAT: Analytic TOP: Competitive markets
ANS: C DIF: LOC: Perfect competition MSC: Definitional
3.
In a perfectly competitive market,
a. no one seller can influence the price of the product. b. price exceeds marginal revenue for each unit sold.
c. average revenue exceeds marginal revenue for each unit sold.
d. administrative barriers can make it difficult for firms to enter an industry.
1
REF: 14-1 NAT: Analytic TOP: Competitive markets
ANS: A DIF: LOC: Perfect competition MSC: Interpretive
4.
Who is a price taker in a competitive market? a. buyers only b. sellers only
c. both buyers and sellers d. neither buyers nor sellers
1
REF: 14-1 NAT: Analytic TOP: Competitive markets
ANS: C DIF: LOC: Perfect competition MSC: Definitional
5.
Competitive markets are characterized by a. a small number of buyers and sellers. b. unique products.
c. the interdependence of firms. d. free entry and exit by firms.
1
REF: 14-1 NAT: Analytic TOP: Competitive markets
ANS: D DIF: LOC: Perfect competition MSC: Definitional
938 ? Chapter 14/Firms in Competitive Markets
6. A market is competitive if (i) firms have the flexibility to price their own product. (ii) each buyer is small compared to the market. (iii) each seller is small compared to the market.
a.
b. c. d. (i) and (ii) only (i) and (iii) only (ii) and (iii) only (i), (ii), and (iii)
2
REF: 14-1 NAT: Analytic TOP: Competitive markets
ANS: C DIF: LOC: Perfect competition MSC: Interpretive
7.
When a firm has little ability to influence market prices it is said to be in a a. competitive market. b. strategic market. c. thin market. d. power market.
1
REF: 14-1 NAT: Analytic TOP: Competitive markets
ANS: A DIF: LOC: Perfect competition MSC: Definitional
8.
In a competitive market, the actions of any single buyer or seller will a. have a negligible impact on the market price.
b. have little effect on market equilibrium quantity but will affect market equilibrium price. c. affect marginal revenue and average revenue but not price.
d. adversely affect the profitability of more than one firm in the market.
2
REF: 14-1 NAT: Analytic TOP: Competitive markets
ANS: A DIF: LOC: Perfect competition MSC: Interpretive
9.
Because the goods offered for sale in a competitive market are largely the same, a. there will be few sellers in the market. b. there will be few buyers in the market. c. only a few buyers will have market power.
d. sellers will have little reason to charge less than the going market price.
2
REF: 14-1 NAT: Analytic TOP: Competitive markets
ANS: D DIF: LOC: Perfect competition MSC: Interpretive
10. Which of the following is not a characteristic of a perfectly competitive market?
a. Firms are price takers.
b. Firms have difficulty entering the market. c. There are many sellers in the market.
d. Goods offered for sale are largely the same.
ANS: B DIF: LOC: Perfect competition MSC: Interpretive
2 REF: 14-1 NAT: Analytic TOP: Competitive markets
11. Which of the following is not a characteristic of a perfectly competitive market?
a. Firms are price takers.
b. Firms can freely enter the market. c. Many firms have market power.
d. Goods offered for sale are largely the same.
ANS: C DIF: LOC: Perfect competition MSC: Interpretive
2 REF: 14-1 NAT: Analytic TOP: Competitive markets