Exercise 8.

1
Suppose a perfectly competitive firm collects total
revenues of $1000 when it produces 200 units; the
marginal costs of producing 200 units is $5. The
firm should

A)
expand production because price is
greater than marginal costs.

B)
contract production because price is
greater than marginal costs.

C)
expand production because price is less
than marginal costs.

D)
contract production because price is less
than marginal costs.

E)
leave production unchanged because
price equals marginal costs.
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Answers to Exercise 8.1

The correct answer is (E)
For perfect competition, the optimal
output occurs where MR (= P) = MC.
Total revenue of 200 units of output is
$1000 means the price of product is
$1000/200 = $5.
Since marginal cost of 200 unit is $5, the
condition MR (= P) = MC is fulfilled.
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Exercise 8.2
In the short run, if a firm chooses to operate and
produce output, it must be the case that

A)
it earns a profit.

B)
total revenues are greater than or equal
to the total cost of fixed and variable factors of
production.

C)
total revenues are greater than or equal
to the cost of fixed factors of production.

D)
total revenues are greater than or equal
to the cost of variable factors of production.

E)
it avoids a loss.
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Answers to Exercise 8.2

The correct answer is (D).
In the short run, a perfectly competitive may earn
a profit, break even or incur a loss.
If it incurs a loss, it will stay in the industry TR >
TVC or P > AVC
If TR < TVC or P < AVC, it will shut down in the
short run.
In the long run, the firm will only remains if it can
at least break even. That is, TR = TC or P = ATC
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Exercise 8.3
If all firms in a perfectly competitive industry are
experiencing economic losses, then

A)
some firms will enter the industry,
seeking new opportunities.

B)
all firms will increase their prices, until
economic profits occurs.

C)
all firms will continue in the industry,
hoping for better times.

D)
some firms will exit the industry, until no
economic losses occur for remaining firms.

E)
all firms will exit the industry, until
economic profits are positive.
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Answers to Exercise 8.3

The correct answer is (D).
If all firms are making losses, then in the
long run some firms which cannot
withstand the loss will exit the industry.
Industry supply decreases, price
increases, losses of existing firms
become smaller until all existing firms
earn normal profit (zero economic profit).
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Exercise 8.4
(1) A profit maximizing perfectly
competitive firm must decide on both
price and quantity of output. Do you
agree? Explain.
(2) In the long run a perfectly
competitive firm can only earns normal
profit. Do you agree? Explain.

Answers to Exercise 8.4

(1) The statement is not valid. Firms have no
control over the price in perfect competition. They
only decides on the output and the optimal output
is P = MR = MC.
(2) The statement is valid. There is free entry and
exit of firms under perfect competition. If firms
are making profits then new firms will enter until
no more profit to be made. If firms are incurring
losses then existing firms will exit the industry
until all remaining firms incur no losses.
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Exercise 8.5
If a single firm, belonging to a perfectly
competitive industry in long run
equilibrium, discovers a significant cost
saving methodology, then what will
happen to this firm in the short run and
in the long run?

Answers to Exercise 8.5

In the short run, this firm will make positive
economic profit since the cost is lower.
But in the long run, new firms will enter the
industry with the same cost savings
technique (due to perfect information).
With supply increases, price will drop until
this firm can only earn normal profit.

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