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CHAPTER7PERFECT COMPETITION

MULTIPLE CHOICE
1. If P = $8 and MC = $5 + 0. 2Q, the competitive firm's profit-maximizing level of output is:
a. 5
b. 0.2
c. 8
d. 15
ANS: D
2. In the long run, firms will offer supply at the point where P = MR = MC if:
a. MC is rising.
b. MC is falling.
c. MC is constant.
d. P > AC
ANS: D
3. Graphically, competitive market supply is measured by the:
a. vertical difference of competitor demand curves.
b. vertical sum of competitor demand curves.
c. horizontal difference of competitor MC curves.
d. horizontal sum of competitor MC curves.
ANS: D
4. For a firm in perfectly competitive market equilibrium:
a. MR < AR
b. P > AC
c. P > MR
d. P = MC
ANS: D
5. Competition tends to be light when:
a. potential entrants are few.
b. capital requirements are nominal.
c. standards for skilled labor and other inputs are modest.
d. regulatory barriers are modest.
ANS: A
6. By itself, a reduction in import tariffs (taxes) will:
a. reduce quantity demanded.
b. enhance domestic competition.
c. enhance the profits of domestic competitors.
d. reduce import competition.
ANS: B
7. Above-normal profits in a perfectly competitive market are caused by:
a. increases in demand that are successfully anticipated.

b. decreases in cost that are successfully anticipated.


c. increases in productivity that are successfully anticipated.
d. luck.
ANS: D
8. In a perfectly competitive market:
a. sellers and buyers have perfect information.
b. entry and exit are difficult.
c. sellers produce similar, but not identical products.
d. each seller can affect the market price by changing output.
ANS: A
9. The firm demand curve in a competitive market is:
a. upward sloping.
b. downward sloping.
c. horizontal.
d. vertical.
ANS: C
10. A firm will earn normal profits when price:
a. equals average total cost.
b. equals average variable cost.
c. equals marginal cost.
d. exceeds minimum average total cost.
ANS: A
11. In the short run, a perfectly competitive firm will shut down and produce nothing if:
a. excess profits equal zero.
b. total cost exceeds total revenue.
c. total variable cost exceeds total revenue.
d. the market price falls below the minimum average total cost.
ANS: C
12. In the long run, firms will exit a perfectly competitive industry if:
a. excess profits exceed zero.
b. excess profits are less than zero.
c. total profit equals zero.
d. excess profits equal zero.
ANS: B
13. Perfect competition always prevails in markets with:
a. few buyers and sellers.
b. many buyers and sellers.
c. an even balance of power between sellers and buyers.
d. a single buyer.
ANS: C
14. In perfectly competitive markets, profits are maximized when:
a. MC = AC

b. P > AC
c. MR = MC
d. MR = P
ANS: C
15. Economic profit:
a. cannot be negative.
b. can exceed the risk-adjusted normal rate of return.
c. is less than the risk-adjusted normal rate of return.
d. does not reflect the cost of owner-supplied inputs.
ANS: B
16. Market structure is not typically characterized on the basis of:
a. the number and size distribution of active buyers and sellers.
b. potential entrants.
c. exit barriers.
d. government regulation.
ANS: D
17. Effects of market structure are not typically measured in terms of:
a. the prices paid by consumers.
b. declining consumer popularity.
c. employment opportunities.
d. pace of product innovation.
ANS: B
18. Price and product quality competition tends to be vigorous when:
a. entry barriers are low.
b. potential entrants are few.
c. product quality information is scarce.
d. the number of active sellers is few.
ANS: A
19. Industry cartels never:
a. give rise to price supports.
b. spur entry when barriers to entry are low.
c. spur exit when exit barriers are low.
d. prompt inefficiency and waste.
ANS: C
20. The rate of return necessary to attract and retain capital investment is called:
a. ROE.
b. economic losses.
c. normal profit.
d. economic profit.
ANS: C
21. In competitive market equilibrium, the firm's:
a. MR = MC and P > AR

b. MR = MC and P > AC
c. AR = AC and MR > MC
d. P = MR = AR = AC = MC
ANS: D
22. At the point of minimum AVC:
a. MC is falling.
b. MC is constant.
c. MC is rising.
d. MC = AVC.
ANS: D
23. So long as P > AVC, the competitive firm's short-run supply curve is equal to:
a. AVC
b. P
c. MC
d. none of these.
ANS: C
24. When profits are maximized in a competitive market, average cost is always:
a. rising.
b. falling.
c. constant.
d. none of these.
ANS: D
25. The following market cannot be described as perfectly competitive:
a. the unskilled labor market.
b. the milk market.
c. discount retailing.
d. the agricultural grain markets.
ANS: B
PROBLEM
1. Competitive Markets. Indicate whether each of the following statements is true or false and why.
A. In long-run equilibrium, every firm in a perfectly competitive industry earns an economic
profit.
B.

Pure competition exists in a market when firms are price makers as opposed to price takers.

C.

A natural monopoly results when the profit-maximizing output level occurs at a point where
long-run average costs are decreasing.

D. Downward-sloping industry demand curves characterize monopoly markets; horizontal


demand curves characterize perfectly competitive markets.
E.

A decrease in the price elasticity of demand would follow an increase in monopoly power.

ANS:
A. False. In long-run equilibrium, every firm in a perfectly competitive industry earns zero
excess profit. Following a decrease in industry prices, high cost producers will be forced to
exit. However, the firms that remain will continue to operate and earn a normal rate of return
on investment.
B.

False. Pure competition exists in a market when individual firms have no influence over
price. Such firms take industry prices as a given.

C.

False. A natural monopoly occurs in a market when the market clearing price, or price where
Demand (Price) = Supply (Marginal Cost), occurs at an output level where long-run average
costs are declining.

D. False. Downward sloping demand curves follow from the law of diminishing marginal utility
and characterize both perfectly competitive and monopoly market structures. Horizontal
demand curves characterize perfectly competitive firms.
E.

True. A decrease in the price elasticity of demand would result following an increase in
monopoly power.

2. Market Structure. Specify whether each of the following statements is true or false and demonstrate
why.
A. A market is confined to all firms and individuals willing and able to buy or sell a particular
product at a given time and place.
B.

The more even the balance of power between sellers and buyers, the more likely it is that the
competitive process will yield maximum benefits.

C.

A close link between the numbers of market participants and the vigor of price competition
is always evident.

D. Market structure describes the competitive environment in the market for any good or
service.
E.

Competitors often benefit from the effects of potential entrants in industries with only a
handful of viable firms.

ANS:
A. False. A market consists of all firms and individuals willing and able to buy or sell a
particular product at a given time and place. This includes individuals and firms currently
engaged in buying and selling a particular product, as well as potential entrants.
B.

True. The more even the balance of power between sellers and buyers, the more likely it is
that the competitive process will yield maximum benefits.

C.

False. A close link between the numbers of market participants and the vigor of price
competition does not always hold true. For example, there are literally thousands of
producers in most major milk markets. Price competition is nonexistent, however, given an
industry cartel that is sustained by a federal program of milk price supports. Nevertheless,
there are few barriers to entry, and individual milk producers struggle to earn a normal

return.
D. True. Market structure is typically characterized on the basis of four important industry
characteristics: the number and size distribution of active buyers and sellers and potential
entrants, the degree to which products are similar or dissimilar, the amount and cost of
information about product price and quality, and conditions of entry and exit.
E.

False. Consumer, not competitors, often benefit from the effects of potential entrants in
industries with only a handful of viable firms. Price competition can be spirited in aircraft
manufacturing, newspaper, Internet access, long-distance telephone service, and other
markets with as few as two competitors. This is particularly true when market participants
are constrained by the viable threat of potential entrants.

3. Product Differentiation. Suggest whether each of the following statements is true or false and
illustrate why.
A. Sources of product differentiation include only physical differences, not merely perceived
differences.
B.

Price competition tends to be most vigorous for products with many actual or perceived
differences.

C.

The availability of good substitutes decreases the degree of competition.

D. Competition tends to be less vigorous when buyers and sellers have easy access to detailed
price/product performance information.
E.

The availability of good complements increases the degree of competition.

ANS:
A. False. Real or perceived differences in the quality of goods and services offered to
consumers lead to product differentiation. Sources of product differentiation include physical
differences, such as those due to superior research and development, plus any perceived
differences due to effective advertising and promotion.
B.

False. Price competition tends to be most vigorous for homogenous products with few actual
or perceived differences.

C.

False. The availability of good substitutes increases the degree of competition.

D. False. Competition is always most vigorous when buyers and sellers have easy access to
detailed price/product performance information.
E.

False. The availability of good substitutes increases the degree of competition.

4. Entry and Exit Conditions. Signify whether each of the following statements is true or false and
document why.
A. A barrier to mobility is any factor or industry characteristic that creates an advantage for
incumbents over new arrivals.
B.

A barrier to entry is any factor or industry characteristic that creates an advantage for large

leading firms over smaller nonleading rivals.


C.

Barriers to entry and mobility sometimes result in compensating advantages for consumers.

D. A barrier to exit is any restriction on the ability of incumbents to redeploy assets from one
industry or line of business to another.
E.

Government actions that create barriers to exit can have the unintended effect of retarding
industrial development.

ANS:
A. False. A barrier to entry is any factor or industry characteristic that creates an advantage for
incumbents over new arrivals.
B.

False. A barrier to mobility is any factor or industry characteristic that creates an advantage
for large leading firms over smaller non-leading rivals.

C.

True. It is worth keeping in mind that barriers to entry and mobility can sometimes result in
compensating advantages for consumers. Even though patents can lead to monopoly profits
for inventing firms, they also spur valuable new product and process development. Although
efficient and innovative leading firms make life difficult for smaller rivals, they can have the
favorable effect of lowering prices and increasing product quality. Therefore, a complete
evaluation of the economic effects of entry barriers involves a consideration of both costs
and benefits realized by suppliers and customers.

D. True. A barrier to exit is any restriction on the ability of incumbents to redeploy assets from
one industry or line of business to another. During the late 1980s, for example, several state
governments initiated legal proceedings to impede plant closures by large employers in the
steel, glass, automobile, and other industries. By imposing large fines or severance taxes or
requiring substantial expenditures for worker retraining, they created significant barriers to
exit.
E.

True. By impeding the asset redeployment that is typical of any vigorous competitive
environment, barriers to exit can dramatically increase both the costs and risks of doing
business. Even though one can certainly sympathize with the difficult adjustments faced by
both workers and firms affected by plant closures, government actions that create barriers to
exit can have the unintended effect of retarding industrial development.

5. Price/Output Determination. Cold Case, Inc., produces beverage containers used by fast food
franchises. This is a perfectly competitive market. The following relation exists between the firm's
beverage container output per hour and total production costs:
Total
Output
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000

Total
Cost
$ 35
85
145
215
295
385
485
610

A. Construct a table showing the marginal cost of paper cup production.


B.

What is the minimum price necessary for the company to supply one thousand cups?

C.

How many cups would the company supply at industry prices of $75 and $100 per thousand?

ANS:
A.
Total
Output
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000

Total
Cost
$ 35
85
145
215
295
385
485
610

Marginal
Cost
-$ 50
60
70
80
90
100
125

B.

The minimum marginal cost of cups is $50, so this also represents the minimum price
necessary to justify supplying a thousand units of output.

C.

In a perfectly competitive market, P = MR. Therefore, E. R. will supply output so long as


price at least covers the marginal cost of production. At a price of $75, Q = 3,000 units of
output can be justified because P = $75 > MCQ = 3,000 = $70. However, production of a fourth
unit is not warranted because P = $75 < MCQ = 4,000 = $80. Similarly, Q = 6,000 could be
justified at a price of $100 because P = $100 = MCQ = 6,000.

6. Firm Supply. The Copy Center specializes in high-volume printing and color copying for small
businesses. This is a fiercely competitive market. The following relation exists between output and
total production costs:
Total
Output
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000

Total
Cost
$ 500
3,500
7,500
12,500
18,500
25,500
33,500
45,000

A. Construct a table showing the marginal of production.


B.

What is the minimum price necessary for the company to supply ten thousand copies?

C.

How many copies would the company supply at industry prices of $5,500 and $7,000 per ten
thousand?

ANS:

A.
Total
Output
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000

Total
Cost
$ 500
3,500
7,500
12,500
18,500
25,500
33,500
45,000

Marginal
Cost
-$ 3,000
4,000
5,000
6,000
7,000
8,000
11,500

B.

The minimum marginal cost of copies per 10,000 units is $3,000, so this also represents the
minimum price necessary to justify supplying ten thousand units of output.

C.

In a perfectly competitive market, P = MR. Therefore, the company will supply output so
long as price at least covers the marginal cost of production. At a price of $5,500, Q =
30,000 units of output can be justified because P = $5,500 > MCQ = 30,000 = $5,000. However,
production of a fourth unit is not warranted because P = $5,500 < MC Q = 40,000 = $6,000.
Similarly, Q = 50,000 could be justified at a price of $7,000 because P = $7,000 = MC Q =
50,000.

7. Firm Supply. Credit Check, Inc., offers credit checking services to credit card companies and
retailers. The following relation exists between the number of credit checks performed and total costs
in this viciously competitive market:
Total
Output
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000

Total
Cost
$ 150
600
1,060
1,540
2,040
2,565
3,115
3,750

A. Construct a table showing the marginal cost of production.


B.

What is the minimum price necessary for the firm to supply one thousand credit checks?

C.

How many credit checks would the firm perform at industry prices of $510 and $550 per
thousand?

ANS:
A.
Total
Output
0
1,000
2,000

Total
Cost
$ 150
600
1,060

Marginal
Cost
-$450
460

3,000
4,000
5,000
6,000
7,000

1,540
2,040
2,565
3,115
3,750

480
500
525
550
635

B.

The minimum marginal cost of output is $450, so this also represents the minimum price
necessary to justify supplying one thousand units of output.

C.

In a perfectly competitive market, P = MR. Therefore, the firm will supply output so long as
price at least covers the marginal cost of production. At a price of $510, Q = 4,000 units of
output can be justified because P = $510 > MCQ = 4,000 = $500. However, production of a fifth
unit is not warranted because P = $510 < MCQ = 5,000 = $525. Similarly, Q = 6,000 could be
justified at a price of $550 because P = $550 = MCQ = 6,000.

8. Firm Supply. Retirement Planning Services.com is a wholesale producer of standardized retirement


plans for high net worth individuals. These plans are produced and e-mailed to financial planners who
incorporate them in their client presentations. The following relation exists between the firm's output
and total production costs in this highly price-competitive market:
Total
Output
0
100
200
300
400
500
600
700

Total
Cost
$ 50
150
275
425
600
800
1,050
1,350

A. Construct a table showing the firm's marginal cost of production.


B.

What is the minimum price necessary for the firm to supply one hundred plans?

C.

How many plans would the firm supply at industry prices of $180 and $300 per hundred?

ANS:
A.
Total
Output
0
100
200
300
400
500
600
700
B.

Total
Cost
$ 50
150
275
425
600
800
1,050
1,350

Marginal
Cost
-$100
125
150
175
200
250
300

The minimum marginal cost is $100, so this also represents the minimum price necessary to
justify supplying one hundred units of output.

C.

In a perfectly competitive market, P = MR. Therefore, the company will supply output so
long as price at least covers the marginal cost of production. At a price of $180, Q = 400
units of output can be justified because P = $180 > MCQ = 400 = $175. However, production of
a fourth unit is not warranted because P = $180 < MCQ = 500 = $200. Similarly, Q = 700 could
be justified at a price of $300 because P = $300 = MCQ = 700.

9. Long-run Firm Supply. The Los Angeles retail market for unleaded gasoline is fiercely price
competitive. Consider the situation faced by a typical gasoline retailer when the local market price for
unleaded gasoline is $2.50 per gallon and total cost (TC) and marginal cost (MC) relations are:
TC = $156,250 + $2.25Q + $0.0000001Q2
MC = TC/Q = $2.25 + $0.0000002Q
and Q is gallons of gasoline. Total costs include a normal profit.
A. Using the firm's marginal cost curve, calculate the profit-maximizing long-run supply from a
typical retailer
B.

Calculate the average total cost curve for a typical gasoline retailer, and verify that average
total costs are less than price at the optimal activity level.

ANS:
A. The marginal cost curve constitutes the long-run supply curve for firms in perfectly
competitive markets if price is greater than average total cost. Because P = MR, the price
necessary to induce firm supply in the long run of a given amount is found by setting P =
MC, provided that P > ATC:
P = $2.25 + $0.0000002Q
2.50 = $2.25 + $0.0000002Q
0.25 = 0.0000002Q
Q = 1,250,000
B.

The average total cost curve is determined by dividing total cost by output:
ATC = ($156,250 + $2.25Q + $0.0000001Q2)/Q
= $156,250/Q + $2.25 + $0.0000001Q
At the Q = 1,250,000 activity level, average total cost is $2.50 and just equal to the market
price:
ATC = $156,250/1,250,000 + $2.25 + $0.0000001(1,250,000)
= $2.50
Because P = MR = MC and P = ATC at the 1,250,000 gallons per year activity level, this is a
sustainable amount of long-run supply from the typical gasoline retailer. With no economic
profits being earned in the industry, there will be no incentive to either grow or contract and
only a normal profit is earned by each competitor in long-run equilibrium.

10. Long-run Firm Supply. The Boston retail market for unleaded gasoline is fiercely price competitive.
Consider the situation faced by a typical gasoline retailer when the local market price for unleaded
gasoline is $1.80 per gallon and total cost (TC) and marginal cost (MC) relations are:
TC = $400,000 + $1.64Q + $0.0000001Q2
MC = TC/Q = $1.64 + $0.0000002Q
and Q is gallons of gasoline. Total costs include a normal profit.
A. Using the firm's marginal cost curve, calculate the profit-maximizing long-run supply from a
typical retailer
B.

Calculate the average total cost curve for a typical gasoline retailer, and verify that average
total costs are less than price at the optimal activity level.

ANS:
A. The marginal cost curve constitutes the long-run supply curve for firms in perfectly
competitive markets if price is greater than average total cost. Because P = MR, the price
necessary to induce firm supply in the long run of a given amount is found by setting P =
MC, provided that P > ATC:
P = $1.64 + $0.0000002Q
1.80 = $1.64 + $0.0000002Q
0.16 = 0.0000002Q
Q = 800,000
B.

The average total cost curve is determined by dividing total cost by output:
ATC = ($400,000 + $1.64Q + $0.0000001Q2)/Q
= $400,000/Q + $1.64 + $0.0000001Q
At the Q = 800,000 activity level, average total cost is $2.22 and more than the market price:
ATC = $400,000/800,000 + $1.64 + $0.0000001(800,000)
= $2.22
Because P = MR = MC while P < ATC at the 800,000 gallons per year activity level, this is
not a sustainable amount of long-run supply from the typical gasoline retailer. Economic
losses being suffered in the industry will cause exit until prices rise or costs fall sufficiently
to ensure that only a normal profit is earned by each competitor in long-run equilibrium.

11. Short-run Firm Supply. Produce Pride, Inc., supplies sweet corn to canneries located throughout the
Missouri River Valley. Like many grain and commodity markets, the market for sweet corn is perfectly
competitive. With $500,000 in fixed costs, the company's total and marginal costs per ton (Q) are:
TC = $500,000 + $400Q + $0.04Q2
MC = TC/Q = $400 + $0.08Q
A. Calculate the industry price necessary to induce short-run firm supply of 5,000, 10,000, and
15,000 tons of sweet corn. Assume that MC > AVC at every point along the firm's marginal
cost curve and that total costs include a normal profit.

B.

Calculate short-run firm supply at industry prices of $400, $1,000, and $2,000 per ton.

ANS:
A. The marginal cost curve constitutes the short-run supply curve for firms in perfectly
competitive industries provided price exceeds average variable cost. Because P = MR, the
price necessary to induce short-run firm supply of a given amount is found by setting P =
MC, assuming P > AVC. Here:
MC = TC/Q = $400 + $0.08Q
Therefore, at:
Q = 5,000: P = MC = $400 + $0.08(5,000) = $800
Q = 10,000: P = MC = $400 + $0.08(10,000) = $1,200
Q = 15,000: P = MC = $400 + $0.08(15,000) = $1,600
(Note: Variable Cost = $400Q + $0.04Q2, and AVC = $400 + $0.04Q, so MC > AVC at each
point along the firm's short-run supply curve.)
B.

When quantity is expressed as a function of price, the firm's supply curve can be written:
P = MC = $400 + $0.08Q
0.08Q = -400 + P
Q = -5,000 + 12.5P
Therefore, at:
P = $400: Q = -5,000 + 12.5($400) = 0
P = $1,000: Q = -5,000 + 12.5($1,000) = 7,500
P = $2,000: Q = -5,000 + 12.5($2,000) = 20,000

12. Short-run Firm Supply. Nature's Best, Inc., supplies asparagus to canners located throughout the
Mississippi River valley. Like several grain and commodity markets, the market for asparagus is
perfectly competitive. Marginal cost per ton of asparagus is:
MC = $1.50 + $0.0005Q
A. Calculate the industry price necessary for the firm to supply 500, 1,000, and 2,000 pounds.
B.

Calculate the quantity supplied by Nature's Best at industry prices of $1.50, $2.25, and $2.75
per pound.

ANS:
A. The marginal cost curve constitutes the supply curve for firms in perfectly competitive
industries. Because P = MR, the price necessary to induce supply of a given amount is found
by setting P = MC. Therefore, at:
Q = 500:
Q = 1,000:
Q = 2,000:

P = MC = $1.50 + $0.0005(500) = $1.75


P = MC = $1.50 + $0.0005(1,000) = $2.00
P = MC = $1.50 + $0.0005(2,000) = $2.50

B.

When quantity is expressed as a function of price, the firm's supply curve can be written:
P = MC = $1.50 + $0.0005Q
0.0005Q = P - 1.50
Q = 2,000P - 3,000
Therefore, at:
P = $1.50:
P = $2.25:
P = $2.75:

Q = 2,000(1.50) - 3,000 = 0
Q = 2,000(2.25) - 3,000 = 1,500
Q = 2,000(2.75) - 3,000 = 2,500

13. Short-run Firm Supply. Whole Fruit, Inc., distributes oranges to wholesalers located throughout the
country. Like several grain and commodity markets, the market for oranges is perfectly competitive.
The marginal cost per crate of oranges is:
MC = $15 + $0.0001Q
A. Calculate the industry price necessary for the firm to supply 25,000, 50,000, and 100,000
crates.
B.

Calculate the quantity supplied by Whole Fruit at industry prices of $15, $22.50, and $27.50
per crate.

ANS:
A. The marginal cost curve constitutes the supply curve for firms in perfectly competitive
industries. Because P = MR, the price necessary to induce supply of a given amount is found
by setting P = MC. Therefore, at:
Q = 25,000:
Q = 50,000:
Q = 100,000:
B.

P = MC = $15 + $0.0001(25,000) = $17.50


P = MC = $15 + $0.0001(50,000) = $20
P = MC = $15 + $0.0001(100,000) = $25

When quantity is expressed as a function of price, the firm's supply curve can be written:
P = MC = $15 + $0.0001Q
0.0001Q = P - 15
Q = 10,000P - 150,000
Therefore, at:
P = $15:
P = $22.50:
P = $27.50:

Q = 10,000(15) - 150,000 = 0
Q = 10,000(22.50) - 150,000 = 75,000
Q = 10,000(27.50) - 150,000 = 125,000

14. Short-run Firm Supply. Give Me a Pane, Inc., distributes window glass to hardware and building
supply chains located throughout the Northeast. Like several grain and commodity markets, the market
for common single-pane glass is perfectly competitive. The company's technology defines a marginal
cost per pound of single-pane glass given by the relation:
MC = $1.00 + $0.0001Q

where Q is pounds of single-pane glass.


A. Calculate the industry price necessary for the firm to supply 10,000, 20,000, and 30,000
pounds.
B.

Calculate the quantity supplied by the firm at industry prices of $1.50, $2.50, and $3.50 per
pound.

ANS:
A. The marginal cost curve constitutes the supply curve for firms in perfectly competitive
industries. Because P = MR, the price necessary to induce supply of a given amount is found
by setting P = MC. Therefore, at:
Q = 10,000:
Q = 20,000:
Q = 30,000:
B.

P = MC = $1.00 + $0.0001(10,000) = $2
P = MC = $1.00 + $0.0001(20,000) = $3
P = MC = $1.00 + $0.0001(30,000) = $4

When quantity is expressed as a function of price, the firm's supply curve can be written:
P = MC = $1.00 + $0.0001Q
0.0001Q = P - 1.00
Q = 10,000P - 10,000
Therefore, at:
P = $1.50:
P = $2.50:
P = $3.50:

Q = 10,000(1.50) - 10,000 = 5,000


Q = 10,000(2.50) - 10,000 = 15,000
Q = 10,000(3.50) - 10,000 = 25,000

15. Long-run Competitive Firm Supply. Calvin's Barbershop is a popularly-priced hair cutter on the
south side of Chicago. Given the large number of competitors, the fact that barbers routinely tailor
services to meet customer needs, and the lack of entry barriers, it is reasonable to assume that the
market is perfectly competitive and that the average $15 price equals marginal revenue, P = MR = $15.
Furthermore, assume that the barbershop's monthly operating expenses are typical of the 50
barbershops in the local market and can be expressed by the following total and marginal cost
functions:
TC = $7,812.50 + $2.5Q + $0.005Q2
MC = $2.5. + $0.01Q
where TC is total cost per month including capital costs, MC is marginal cost, and Q is the number of
hair cuts provided. Total costs include a normal profit.
A. Calculate Calvin's profit-maximizing output level.
B.

Calculate the Calvin's economic profits at this activity level. Is this activity level sustainable
in the long run?

ANS:
A. The optimal output level can be determined by setting marginal revenue equal to marginal

cost and solving for Q:


MR = MC
$15 = $2.50 + $0.01Q
$0.01Q = $12.50
Q = 1,250 hair cuts per month.
B.

Because the cost of capital is already included in the total cost function, any excess of
revenues over total cost represents economic profits. At this output level, maximum
economic profits are
= TR - TC
= $15Q - $7,812.5. - $2.5Q - $0.005Q2
= $15(1,250) - $7,812.5. - $2.5(1,250) - $0.005(1,2502)
= $0
The Q = 1,250 activity level results in zero economic profits. This means that the barbershop
is just able to obtain a normal or risk-adjusted rate of return on investment because capital
costs are already included in the cost function. The Q = 1,250 output level is also the point of
minimum average production costs (ATC = MC = $15), and thereby constitutes the firm's
long-run sustainable supply. Finally, with 500 identical firms in the local area, industry
output totals 62,500 hair cuts per month.

16. Short-run Market Supply. Carolina Textiles, Inc., is a small manufacturer of cotton linen that it sells
in a perfectly competitive market. Given $100,000 in fixed costs per day, the daily total cost function
for this product is described by:
TC = $100,000 + $2Q + $0.0625Q2
MC = TC/Q = $2 + $0.125Q
where Q is units of cotton linen produced per day. Assume that MC > AVC at every point along the
firm's marginal cost curve, and that total costs include a normal profit.
A. Derive the firm's supply curve, expressing quantity as a function of price.
B.

Derive the market supply curve if North Carolina Textiles is one of 1,000 competitors.

C.

Calculate market supply per day at a market price of $47 per unit.

ANS:
A. The perfectly competitive firm will supply output so long as it is profitable to do so. Because
P = MR in perfectly competitive markets, the firm supply curve is given by the relation:
P = MC = TC/Q = $2 + $0.125Q
when quantity is expressed as a function of price, the firm supply curve is:
P = $2 + $0.125Q
0.125Q = -2 + P
QS = -16 + 8P

(Note: Variable Cost = $2Q + $0.0625Q2, and AVC = $2 + $0.0625Q, so MC > AVC at each
point along the firm's short-run supply curve.)
B.

If the company is one of 1,000 such competitors, the industry supply curve is found by
simply multiplying the firm supply curve derived in part A by 1,000. This is equivalent to a
horizontal summation of all 1,000 individual firm supply curves. When quantity is expressed
as a function of price:
QS = 1,000 (-16 + 8P)
= -16,000 + 8,000P
When price is expressed as a function of quantity:
QS = -16,000 + 8,000P
8,000P = 16,000 + QS
P = $2 + $0.000125QS

C.

QS = -16,000 + 8,000P
= -16,000 + 8,000($47)
= 360,000 units per day

17. Short-run Market Supply. The Fertilizer Supply Co. is a typical distributor in the perfectly
competitive fertilizer supply industry. Its marginal cost of output is:
MC = $250 + $0.05Q
where Q is tons of fertilizer produced per year.
A. Derive the firm's supply curve, expressing quantity as a function of price.
B.

Derive the industry supply curve if the firm is one of 400 competitors.

C.

Calculate industry supply per year at a market price of $300 per ton.

ANS:
A. The perfectly competitive firm will supply output so long as it is profitable to do so. Because
P = MR in perfectly competitive markets, the firm supply curve is given by the relation:
P = MC = $250 + $0.05Q
when quantity is expressed as a function of price, the firm supply curve is:
P = $250 + $0.05Q
0.05Q = P - 250
QS = -5,000 + 20P
B.

If the company is one of 400 such competitors, the industry supply curve is found by simply
multiplying the firm supply curve derived in part A by 400. This is equivalent to a horizontal
summation of all 400 individual firm supply curves. When quantity is expressed as a
function of price we find:
Q S = 400(-5,000 + 20P)

= -2,000,000 + 8,000P
When price is expressed as a function of quantity:
QS = -2,000,000 + 8,000P
8,000P = 2,000,000 + QS
P = $250 + $0.000125QS
C.

QS = -2,000,000 + 8,000P
= -2,000,000 + 8,000($300)
= 400,000

18. Short-run Market Supply. Motor City Music is a local distributor of musical CDs featuring
compilations of classic rock recordings by various artists. Motor City's marginal cost of output is
described by the relation:
MC = $2.50 + $0.00025Q
where Q is CDs sold per year.
A. Derive the firm's supply curve, expressing quantity as a function of price.
B.

Derive the industry supply curve if the firm is one of 100 competitors.

C.

Calculate industry supply per year at a market price of $5 per unit.

ANS:
A. The perfectly competitive firm will supply output so long as it is profitable to do so. Because
P = MR in perfectly competitive markets, the firm supply curve is given by the relation:
P = MC = $2.50 + $0.00025Q
when quantity is expressed as a function of price, the firm supply curve is:
P = $2.50 + $0.00025Q
0.00025Q = P - 2.50
QS = -10,000 + 4,000P
B.

If the company is one of 100 such competitors, the industry supply curve is found by simply
multiplying the firm supply curve derived in part A by 100. This is equivalent to a horizontal
summation of all 100 individual firm supply curves. When quantity is expressed as a
function of price we find:
QS = 100(-10,000 + 4,000P)
= -1,000,000 + 400,000P
When price is expressed as a function of quantity:
QS = -1,000,000 + 400,000P
400,000P = 1,000,000 + QS
P = $2.50 + $0.0000025QS

C.

QS = -1,000,000 + 400,000P
= -1,000,000 + 400,000($5)
= 1,000,000

19. Short-run Market Supply. The Magazine Delivery Company is a typical firm in the perfectly
competitive magazine delivery business. The company delivers magazines and stocks magazine racks
at convenience stores located throughout the state of Kentucky. Marginal costs of service are described
by the relation:
MC = $5 + $0.4Q
where Q is racks of magazines delivered and serviced per week.
A. Derive the firm's supply curve, expressing quantity as a function of price.
B.

Derive the market supply curve if the company is one of 200 competitors.

C.

Calculate market supply per week at a market price of $25 per rack delivered and serviced.

ANS:
A. The perfectly competitive firm will supply output so long as it is profitable to do so. Because
P = MR in perfectly competitive markets, the firm supply curve is given by the relation:
P = MC = $5 + $0.4Q
when quantity is expressed as a function of price, the firm supply curve is:
P = $5 + $0.4QS
0.4QS = P - 5
QS = -12.5. + 2.5P
B.

If the company is one of 200 such competitors, the industry supply curve is found by simply
multiplying the firm supply curve derived in part A by 200. This is equivalent to a horizontal
summation of all 200 individual firm supply curves. When quantity is expressed as a
function of price:
QS = 200(-12.5. + 2.5P)
= -2,500 + 500P
When price is expressed as a function of quantity:
QS = -2,500 + 500P
500P = 2,500 + QS
P = $5 + $0.002QS

C.

QS = -2,500 + 500P
= -2,500 + 500($25)
= 10,000 per week

20. Perfectly Competitive Equilibrium. Fuel costs have risen sharply during recent years as
consumption, refining and production costs have increased. Demand and supply conditions in the
perfectly competitive domestic crude oil market are:

P = $105 - 1.5QD

(Demand)

P = $37.50+ 0.75QS

(Supply)

where P is price per barrel and Q is quantity in millions of barrels per day.
A. Graph industry demand and supply curves.
B.

Determine both graphically and algebraically the equilibrium industry price/output


combination.

ANS:
A.

B.

From the graph, it is clear that Q D = QS = 30(000,000) at a price of $60 per barrel. Thus,
P = $60 and Q = 30(000,000) is the equilibrium price/output combination. Algebraically,
PD = PS
$105 - $1.5QD = $37.50 + $0.75QS
2.25Q = 67.50
Q = 30
At Q = 30, the price for demand and supply equal $60 because:
Demand: P = $105 - $1.5(30) = $60
Supply: P = $37.50 + $0.75(30) = $60

21. Perfectly Competitive Equilibrium. Lawn mowing services are supplied by a host of individuals in
the suburb of Westbrook. Demand and supply conditions in the perfectly competitive domestic for
lawn mowing services are:
P = $75 - 1.75QD

(Demand)

P = $2QS

(Supply)

where P is price per lawn mowed and Q is quantity of lawns mowed per day.
A. Algebraically determine the equilibrium industry price/output combination.
B.

Confirm this by graphing industry demand and supply curves.

ANS:
A. Algebraically,
PD = PS
$75 - $1.75QD = $2QS
3.75Q = 75
Q = 20
At Q = 20, the price for demand and supply equal $40 because:
Demand: P = $75 - $1.75(20) = $40
Supply: P = $2(20) = $40
B.

From the graph, it is clear that QD = QS = 20 at a price of $40 per lawn mowed. Thus,
P = $40 and Q = 20 is the equilibrium price/output combination.

22. Perfectly Competitive Equilibrium. Fuel costs have risen quickly during recent years as
consumption, refining and production costs have risen sharply. Supply and demand conditions in the
perfectly competitive domestic crude oil market are:
QS = -60 + 2P

(Supply)

QD = 90 - P

(Demand)

where Q is quantity in millions of barrels per day, and P is price per barrel.

A. Graph industry supply and demand curves.


B.

Determine both graphically and algebraically the equilibrium industry price/output


combination.

ANS:
A.

B.

From the graph, it is clear that QD = QS = 40(000,000) at a price of $50 per barrel. Thus,
P = $50 and Q = 40(000,000) is the equilibrium price/output combination. Algebraically,
QD = QS
90 - P = -60 + 2P
3P = 150
P = $50
Both demand and supply equal 40(000,000) because:
Demand: QD = 90 - 1(50) = 40(000,000)
Supply: QS = -60 + 2(50) = 40(000,000)

23. Perfectly Competitive Equilibrium. Office building maintenance plans call for the stripping, waxing,
and buffing of ceramic floor tiles. This work is often contracted out to office maintenance firms, and
both technology and labor requirements are very basic. Supply and demand conditions in this perfectly
competitive service market in St. Paul, Minnesota are:
QS = -20 + 2P

(Supply)

QD = 80 - 2P

(Demand)

where Q is thousands of hours of floor reconditioning per month, and P is the price per hour.

A. Algebraically determine the market equilibrium price/output combination.


B.

Use a graph to confirm your answer.

ANS:
A. Algebraically,
QD = QS
80 - 2P = -20 + 2P
4P = 100
P = $25 per hour
Both demand and supply equal 30(000) because:
Demand: QD = 80 - 2($25) = 30(000)
Supply: QS = -20 + 2($25) = 30(000)
B.

From the graph, see that QD = QS = 30(000) at a contract price of $25 per hour. Thus, P = $25
per hour and Q = 30(000) is the equilibrium price/output combination.

24. Competitive Market Equilibrium. Happy Valley Supply, Inc., provides recycled toner cartridges for
printers. Like its competitors, Happy Valley must meet strict specifications. As a result, the
replacement toner cartridge market can be regarded as perfectly competitive. Total and marginal cost
relations per week are:
TC = $4,000 + $5Q + $0.1Q2
MC = TC/Q = $5 + $0.2Q
where Q is the number of recycled toner cartridges.

A. Calculate Happy Valley's optimal output and profits if prices are stable at $55 per toner
cartridge.
B.

Calculate Happy Valley's optimal output and profits if prices rise to $65 per unit.

C.

If Happy Valley is typical of firms in the industry, calculate the firm's equilibrium output,
price, and profit levels.

ANS:
A. Because the industry is perfectly competitive, P = MR = $55. Set MR = MC to find the
profit-maximizing activity level.
MR = MC
$55 = $5 + $0.2Q
0.2Q = 50
Q = 100
= TR - TC
= $55(100) - $4,000 - $5(100) - $0.1(1002)
= $0
B.

After a rise in prices to $65, the optimal activity level rises to Q = 120 because:
MR = MC
$65 = $5 + $0.2Q
0.2Q = 60
Q = 120
= TR - TC
= $65(120) - $4,000 - $5(120) - $0.1(1202)
= $1,760

C.

In equilibrium, P = AC and MR = MC at the point where average cost is minimized. To find


the point of minimum average costs we set:
MC = AC = TC/Q
$5 + $0.2Q = ($4,000 + $5Q + $0.1Q2)/Q
5 + 0.2Q =

+ 5 + 0.1Q

0.1Q =
Q=
= 200
P = AC
=
= $45

+ $5 + $0.1(200)

= TR - TC
= $45(200) - $4,000 - $5(200) - $0.1(2002)
= $0

25. Competitive Market Equilibrium. Syracuse Paper supplies printer paper in upstate New York. Like
the output of other wholesale distributors, Syracuse Paper must meet strict guidelines and the printer
paper supply industry can be regarded as perfectly competitive. Total and marginal cost relations are:
TC = $3,600 + $5Q + $0.01Q2
MC = TC/Q = $5 + $0.02Q
where Q is cases of printer paper per day.
A. Calculate the firm's optimal output and profits if prices are stable at $20 per case.
B.

Calculate optimal output and profits if prices rise to $25 per case.

C.

If Syracuse Paper is typical of firms in the industry, calculate the firm's equilibrium output,
price, and profit levels.

ANS:
A. Because the industry is perfectly competitive, P = MR = $20. Set MR = MC to find the
profit-maximizing activity level.
MR = MC
$20 = $5 + $0.02Q
0.02Q = 15
Q = 750 per day
= TR - TC
= $20(750) - $3,600 - $5(750) - $0.01(7502)
= $2,025
B.

After a rise in prices to $25, the optimal activity level grows to Q = 1,000 because:
MR = MC
$25 = $5 + $0.02Q
0.02Q = 20
Q = 1,000
= TR - TC
= $25(1,000) - $3,600 - $5(1,000) - $0.01(1,0002)
= $6,400

C.

In equilibrium, P = AC and MR = MC at the point where average cost is minimized. To find


the point of minimum average costs set:
MC = AC = TC/Q
$5 + $0.02Q = ($3,600 + $5Q + $0.01Q2)/Q
5 + 0.02Q =
0.01Q =

+ 5 + 0.01Q

Q2 =
Q=
= 600
P = AC
=
= $17

+ $5 + $0.01(600)

= TR - TC
= $17(600) - $3,600 - $5(600) - $0.01(6002)
= $0