Exercise 9 SolutionChapter 11 Firms in Perfectly Competitive Markets

11.1 Perfectly Competitive Markets

1) Which of the following is not a characteristic of a perfectly competitive market structure?A) There are a very large number of firms that are small compared to the market.B) All firms sell identical products.C) There are no restrictions to entry by new firms.D) There are restrictions on exit of firms. Answer: DComment: RecurringDiff: 1 Page Ref: 368/368Topic: Market StructuresObjective: LO1: Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve.AACSB: Reflective ThinkingSpecial Feature: None

2) Which of the following is a characteristic of an oligopolistic market structure?A) There are few dominant sellers.B) Each firm sells a unique product.C) It is easy for new firms to enter the industry.D) Each firm need not react to the actions of rivals.Answer: AComment: RecurringDiff: 1 Page Ref: 368/368Topic: Market StructuresObjective: LO1: Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve.AACSB: Reflective ThinkingSpecial Feature: None

3) Perfect competition is characterized by all of the following exceptA) heavy advertising by individual sellers.B) homogeneous products.C) sellers are price takers.D) a horizontal demand curve for individual sellers.Answer: AComment: RecurringDiff: 1 Page Ref: 369/369Topic: Characteristics of Perfectly Competitive Firms

Objective: LO1: Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve.AACSB: Reflective ThinkingSpecial Feature: None

4) Which of the following is the best example of a perfectly competitive industry?A) wheat productionB) steel productionC) electricity productionD) airplane productionAnswer: AComment: RecurringDiff: 2 Page Ref: 368/368Topic: Market StructuresObjective: LO1: Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve.AACSB: Reflective ThinkingSpecial Feature: None

5) Both individual buyers and sellers in perfect competitionA) can influence the market price by their own individual actions.B) can influence the market price by joining with a few of their competitors. C) have to take the market price as a given.D) have the market price dictated to them by government. Answer: CComment: RecurringDiff: 1 Page Ref: 369/369Topic: Characteristics of Perfectly Competitive FirmsObjective: LO1: Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve.AACSB: Reflective ThinkingSpecial Feature: None

6) Suppose the equilibrium price in a perfectly competitive industry is $15 and a firm in the industry charges $21. Which of the following will happen?A) The firm's profits will increase.B) The firm's revenue will increase.C) The firm will not sell any output.D) The firm will sell more output than its competitors.Answer: CComment: RecurringDiff: 1 Page Ref: 369/369Topic: Characteristics of Perfectly Competitive FirmsObjective: LO1: Explain what a perfectly competitive market is and why a perfect

competitor faces a horizontal demand curve.AACSB: Reflective ThinkingSpecial Feature: None

7) An individual seller in perfect competition will not sell at a price lower than the market price becauseA) demand for the product will exceed supply. B) the seller would start a price war.C) the seller can sell any quantity she wants at the prevailing market price.D) demand is perfectly inelastic.Answer: CComment: RecurringDiff: 2 Page Ref: 369/369Topic: Characteristics of Perfectly Competitive FirmsObjective: LO1: Explain what a perfectly competitive market is and why a perfect competitor faces a horizontal demand curve.AACSB: Reflective ThinkingSpecial Feature: None

11.2 How a Firm Maximizes Profit in a Perfectly Competitive Market

1) If the market price is $25, the average revenue of selling five units isA) $5.B) $12.50.C) $25.D) $125.Answer: CComment: RecurringDiff: 2 Page Ref: 371-372/371-372Topic: Average Revenue and Marginal RevenueObjective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Reflective ThinkingSpecial Feature: None

2) Which of the following is not true for a firm in perfect competition?A) Profit equals total revenue minus total cost.B) Price equals average revenue.C) Average revenue is greater than marginal revenue.D) Marginal revenue equals the change in total revenue from selling one more unit. Answer: CComment: RecurringDiff: 2 Page Ref: 371-372/371-372Topic: Average Revenue and Marginal Revenue

Objective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Reflective ThinkingSpecial Feature: None

3) A perfectly competitive firm produces 3,000 units of a good at a total cost of $36,000. The price of each good is $10. Calculate the firm's short-run profit or loss.A) loss of $6,000B) profit of $6,000C) profit of $30,000D) There is insufficient information to answer the question.Answer: AComment: RecurringDiff: 1 Page Ref: 372-374/372-374Topic: Profit-Maximizing Level of OutputObjective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Reflective ThinkingSpecial Feature: None

4) If, for a perfectly competitive firm, price exceeds the marginal cost of production, the firm should A) increase its output.B) reduce its output.C) keep output constant and enjoy the above normal profit.D) lower the price.Answer: AComment: RecurringDiff: 1 Page Ref: 372-374/372-374Topic: Profit-Maximizing Level of OutputObjective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Reflective ThinkingSpecial Feature: None

Figure 11-1

5) Refer to Figure 11-1. What is the amount of profit if the firm produces Q2 units?

A) It is equal to the vertical distance c to g.

B) It is equal to the vertical distance c to Q2.

C) It is equal to the vertical distance g to Q2.

D) It is equal to the vertical distance c to g multiplied by Q2 units.

Answer: AComment: RecurringDiff: 1 Page Ref: 372-374/372-374Topic: Profit-Maximizing Level of OutputSkill: GraphingObjective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Analytic SkillsSpecial Feature: None

6) Refer to Figure 11-1. Suppose the firm is currently producing Q2 units. What

happens if it expands output to Q3 units?

A) Its profit increases by the size of the vertical distance df.B) It makes less profit.C) It incurs a loss.D) It will be moving toward its profit maximizing output. Answer: BComment: RecurringDiff: 1 Page Ref: 372-374/372-374

Topic: Profit-Maximizing Level of OutputSkill: GraphingObjective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Analytic SkillsSpecial Feature: None

7) Refer to Figure 11-1. The firm breaks even at an output level of

A) Q1 units.

B) Q2 units.

C) Q3 units.

D) Q4 units.

Answer: DComment: RecurringDiff: 1 Page Ref: 372-374/372-374Topic: Profit-Maximizing Level of OutputSkill: GraphingObjective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Analytic SkillsSpecial Feature: None

8) Refer to Figure 11-1. What happens if the firm produces more than Q4 units?

A) Its profit increases.B) It makes a loss.C) Its total revenue is increasing faster than its total cost.D) It could make a profit or a loss depending on what happens to demand.Answer: BComment: RecurringDiff: 1 Page Ref: 372-374/372-374Topic: Profit-Maximizing Level of OutputSkill: GraphingObjective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Analytic SkillsSpecial Feature: None

9) Refer to Figure 11-1. Why is the total revenue curve a ray from the origin?A) because revenue increases at an increasing rate

B) because revenue increases at a decreasing rateC) because the firm can sell its product at a constant priceD) because the firm must lower its price to sell more Answer: CComment: RecurringDiff: 2 Page Ref: 372/372Topic: Total RevenueSkill: GraphingObjective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Analytic SkillsSpecial Feature: None

10) In a graph with output on the horizontal axis and total revenue on the vertical axis, what is the shape of the total revenue curve for a perfectly competitive seller?A) U-shapedB) inverted U-shapedC) a horizontal lineD) a ray from the originAnswer: DComment: RecurringDiff: 2 Page Ref: 372/372Topic: Total RevenueObjective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Reflective ThinkingSpecial Feature: None

11) Assume that price is greater than average variable cost. If a perfectly competitive seller is producing at an output where price is $11 and the marginal cost is $14.54, then to maximize profits the firm should A) continue producing at the current output.B) produce a larger level of output. C) produce a smaller level of output. D) There is not enough information given to answer the question.Answer: CComment: RecurringDiff: 2 Page Ref: 372-374/372-374Topic: Profit-Maximizing Level of OutputObjective: LO2: Explain how a firm maximizes profits in a perfectly competitive market.AACSB: Reflective ThinkingSpecial Feature: None

11.3 Illustrating Profit or Loss on the Cost Curve Graph

1) A firm's total profit can be calculated as all of the following exceptA) total revenue minus total cost.B) average profit per unit times quantity sold.C) (price minus average total cost) times quantity sold.D) marginal profit times quantity sold.Answer: DComment: RecurringDiff: 2 Page Ref: 374-375/374-375Topic: ProfitObjective: LO3: Use graphs to show a firm's profit or loss.AACSB: Reflective ThinkingSpecial Feature: None

Figure 11-2

2) Refer to Figure 11-2. Suppose the prevailing price is P1 and the firm is currently

producing its loss-minimizing quantity. Identify the area that represents the loss.

A) P2 deP1

B) P3cbP1

C) P3caP0

D) 0P1 bQ1

Answer: BComment: RecurringDiff: 2 Page Ref: 374-375/374-375Topic: Profit and Loss

Skill: GraphingObjective: LO3: Use graphs to show a firm's profit or loss.AACSB: Analytic SkillsSpecial Feature: None

3) All of the following can be used to compute average profit exceptA) marginal profit minus marginal cost.B) total profit divided by quantity.C) average revenue minus average total costD) price minus average total cost.Answer: ADiff: 2 Page Ref: 377/377Topic: ProfitObjective: LO3: Use graphs to show a firm's profit or loss.AACSB: Reflective ThinkingSpecial Feature: Don't Let This Happen to YOU!: Remember That Firms Maximize Their Total Profits, Not Their Profits per Unit

11.4 Deciding Whether to Produce or to Shut Down in the Short Run

1) If, for a given output level, a perfectly competitive firm's price is less than its average variable cost, the firmA) is earning a profit.B) should shut down.C) should increase output.D) should increase price.Answer: BComment: RecurringDiff: 2 Page Ref: 379-380/379-380Topic: Shutting Down in the Short RunObjective: LO4: Explain why firms may shut down temporarily.AACSB: Reflective ThinkingSpecial Feature: None

2) When a perfectly competitive firm finds that its market price is below its minimum average variable cost, it will sellA) the output where marginal revenue equals marginal cost.B) any positive output the entrepreneur decides upon because all of it can be sold.C) nothing at all; the firm shuts down.D) the output where average total cost equals price. Answer: CComment: RecurringDiff: 2 Page Ref: 379-380/379-380Topic: Shutting Down in the Short Run

Objective: LO4: Explain why firms may shut down temporarily.AACSB: Reflective ThinkingSpecial Feature: None

3) Val Alvarado, an accountant, quit his $80,000-a-year job and bought an existing laundry from its previous owner, Ricky White. The lease has five years remaining and requires a monthly payment of $4,000. Val's explicit cost amounts to $3,000 per month more than his revenue. Should Val continue operating his business?A) Val's explicit cost exceeds his total revenue. He should shut down his laundry.B) Val should continue to run the laundry until his lease runs out. C) If Val's marginal revenue is greater than or equal to his marginal cost, then he should stay in business. D) This cannot be determined without information on his revenue. Answer: BDiff: 2 Page Ref: 380/380Topic: Shutting Down in the Short RunObjective: LO4: Explain why firms may shut down temporarily.AACSB: Reflective ThinkingSpecial Feature: Making the Connection: When to Close a Laundry

4) If total variable cost exceeds total revenue at all output levels, a perfectly competitive firm A) should produce in the short run.B) is making short-run profits.C) should shut down in the short run.D) has covered its fixed cost. Answer: CComment: RecurringDiff: 2 Page Ref: 379-380/379-380Topic: Shutting Down in the Short RunObjective: LO4: Explain why firms may shut down temporarily.AACSB: Reflective ThinkingSpecial Feature: None

5) If a firm shuts down in the short run, A) its loss equals zero.B) its loss equals its fixed cost.C) is makes zero economic profit.D) its total revenue is not large enough to cover its fixed cost. Answer: BComment: RecurringDiff: 2 Page Ref: 379-380/379-380Topic: Shutting Down in the Short RunObjective: LO4: Explain why firms may shut down temporarily.

AACSB: Reflective ThinkingSpecial Feature: None

11.5 "If Everyone Can Do It, You Can't Make Money at It" – The Entry and Exit of Firms in the Long Run

1) Which of the following statements is correct?A) Economic profit takes into account all costs involved in producing a product. B) Accounting profit is not relevant in preparing the firm's financial statement.C) Economic profit always exceeds accounting profit. D) Accounting profit is the same as economic profit.Answer: AComment: RecurringDiff: 1 Page Ref: 382-383/382-383Topic: ProfitObjective: LO5: Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run.AACSB: Reflective ThinkingSpecial Feature: None

2) If a typical firm in a perfectly competitive industry is earning profits, thenA) all firms will continue to earn profits.B) new firms will enter in the long run causing market supply to decrease, market price to rise and profits to increase. C) new firms will enter in the long run causing market supply to increase, market price to fall and profits to decrease.D) the number of firms in the industry will remain constant in the long run.Answer: CComment: RecurringDiff: 1 Page Ref: 383-384/383-384Topic: Long-Run EquilibriumObjective: LO5: Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run.AACSB: Reflective ThinkingSpecial Feature: None

3) If, in a perfectly competitive industry, the market price facing a firm is above its average total cost at the output where marginal revenue equals marginal cost, thenA) firms are breaking even.B) new firms are attracted to the industry.C) existing firms will exit the industry.D) market supply will remain constant.Answer: BComment: Recurring

Diff: 2 Page Ref: 383-384/383-384Topic: Long-Run EquilibriumObjective: LO5: Explain how entry and exit ensure that perfectly competitive firms earn zero economic profit in the long run.AACSB: Reflective ThinkingSpecial Feature: None

11.6 Perfect Competition and Efficiency

1) Which of the following describes a situation in which a good or service is produced at the lowest possible cost?A) productive efficiency B) allocative efficiencyC) marginal efficiencyD) profit maximizationAnswer: AComment: RecurringDiff: 1 Page Ref: 389/389Topic: Productive EfficiencyObjective: LO6: Explain how perfect competition leads to economic efficiency.AACSB: Reflective ThinkingSpecial Feature: None

2) The perfectly competitive market structure benefits consumers becauseA) firms do not produce goods at the lowest possible price in the long run.B) firms are forced by competitive pressure to be as efficient as possible.C) firms add a much smaller markup over average cost than firms in any other type of market structure. D) firms produce high quality goods at low prices.Answer: BComment: RecurringDiff: 2 Page Ref: 389/389Topic: EfficiencyObjective: LO6: Explain how perfect competition leads to economic efficiency.AACSB: Reflective ThinkingSpecial Feature: None

3) Which of the following describes a situation in which every good or service is produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it?A) productive efficiency B) allocative efficiencyC) marginal efficiencyD) profit maximization

Answer: BComment: RecurringDiff: 1 Page Ref: 391/391Topic: Allocative EfficiencyObjective: LO6: Explain how perfect competition leads to economic efficiency.AACSB: Reflective ThinkingSpecial Feature: None

4) A perfectly competitive industry achieves allocative efficiency becauseA) goods and services are produced at the lowest possible cost.B) goods and services are produced up to the point where the last unit provides a marginal benefit to consumers equal to the marginal cost of producing it.C) it produces where market price equals marginal production cost. D) firms carry production surpluses. Answer: BComment: RecurringDiff: 2 Page Ref: 391/391Topic: Allocative EfficiencyObjective: LO6: Explain how perfect competition leads to economic efficiency.AACSB: Reflective ThinkingSpecial Feature: None

5) An increase in demand for "green-certified" products will ________ a firm's economic profit, and the increase in costs to have a product certified as "green" will ________ a firm's economic profit.A) increase; increaseB) increase; decreaseC) decrease; increase D) decrease; decreaseAnswer: BDiff: 1 Page Ref: 392/392Topic: ProfitObjective: LO6: Explain how perfect competition leads to economic efficiency.AACSB: Analytic SkillsSpecial Feature: An Inside LOOK at Policy: It Isn't Easy-or Cheap-to Be Green