Solution Manual for Macroeconomics for Today, 9th Edition

Solution Manual for Macroeconomics for Today, 9th

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Chapter 8
Perfect Competition
CHAPTER SUMMARY

Perfect Competition is characterized by: 1) very large number of sellers, 2) firms sell a homogenous
product, 3) virtually no barriers to entry or exit. Firms are also price takers.
Like all firms, the competitive firm attempts to maximize profits. This can be accomplished
through the "total revenue-total cost method," or the "marginal revenue equals marginal cost method." By
producing an output in which marginal revenue equals marginal cost the firm will not only guarantee that
it is maximizing profit, if a profit is being earned, but will be minimizing losses if they are incurred. The
shut-down rule introduced in this chapter is: shut down if price (marginal revenue) is less than average
variable cost. However, two alternative rules would be to shut down if operating losses are greater than
total fixed cost; or, if total revenue is less than total variable cost.
A competitive firm's short-run supply curve is its' MC curve above minimum AVC. The industry's
short-run supply curve is the horizontal summation of all firm's short-run MC curves above minimum
AVC.
In the short run, a competitive firm may earn an economic profit, only a zero economic profit (only a
normal profit), or incur losses. But, in the long run (over time), only a normal profit can be earned
because of the lack of barriers to entry and exit. Long-run competitive equilibrium occurs when the firm
earns a normal profit by producing where price equals minimum long-run average cost equals minimum
short-run average cost equals short-run marginal cost.
The three possible perfectly competitive industry long-run supply curves depend on whether a
constant-cost, decreasing-cost, or increasing-cost industry is experienced.

NEW CONCEPTS INTRODUCED

perfectly competitive firm's short-run supply curve market structure

perfectly competitive industry's short-run supply curve perfect competition
perfectly competitive industry's long-run supply curve marginal revenue (MR)
constant-cost industry price taker
decreasing-cost industry increasing-cost industry

LEARNING OBJECTIVES
After completing this chapter, you should be able to:

1. Define market structure.

2. Describe the characteristics of perfect competition.
3. Identify a price taker.
4. Explain short-run profit maximization.
5. Define marginal revenue.
6. Derive the short-run supply curve.
7. Explain long-run competitive equilibrium.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
2 Economics for Today

CHAPTER OUTLINE
8-1 Perfect Competition
a. Characteristics of Perfect Competition
1. Large Number of Small Firms
2. Homogeneous Product
3. Very Easy Entry and Exit

b. The Perfectly Competitive Firm as a Price-Taker

Exhibit 1 "The Market Price and Demand for the Perfectly Competitive Firm"

8-2 Short-Run Profit Maximization for a Perfectly Competitive Firm

Exhibit 2 "Short-Run Profit Maximization Schedule for Computech as a Perfectly Competitive

Firm"

a. The Total Revenue-Total Cost Method

Exhibit 3 "Short-Run Profit Maximization Using the Total Revenue-Total Cost Method for a
Perfectly Competitive Firm"

b. The Marginal Revenue Equals Marginal Cost Method

Exhibit 4 "Short-Run Profit Maximization Using the Marginal Revenue Equals Marginal Cost
Method for a Perfectly Competitive Firm"

8-3 Short-Run Loss Minimization for a Perfectly Competitive Firm

a. A Perfectly Competitive Firm Facing a Short-Run Loss

Exhibit 5 "Short-Run Loss Minimization Using the Marginal Revenue Equals Marginal Cost
Method for a Perfectly Competitive Firm"

b. A Perfectly Competitive Firm Shutting Down

Exhibit 6 "The Short-Run Shutdown Point for a Perfectly Competitive Firm"

Checkpoint: "Should Hotels Offer Rooms at the Beach for Only $50 a Night?

8-4 Short-Run Supply Curves under Perfect Competition

a. The Perfectly Competitive Firm's Short-Run Supply Curve

Exhibit 7 "The Perfectly Competitive Firm's Short-Run Supply Curve"

b. The Perfectly Competitive Industry's Short-Run Supply Curve

Exhibit 8 "Deriving the Industry Short-Run Supply Curve"

c. Short-Run Equilibrium for a Perfectly Competitive Firm

Exhibit 9 "Short-Run Perfectly Competitive Equilibrium"

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 Chapter 8: Perfect Competition 3

8-5 Long-Run Supply Curves under Perfect Competition

a. Long-Run Equilibrium for a Perfectly Competitive Firm

Exhibit 10 "Long-Run Perfectly Competitive Equilibrium"

b. Three Types of Long-Run Supply Curves

Checkpoint: "Are You in Business for the Long-Run?

I. Constant-Cost Industry

Exhibit 11 "Long-Run Supply in a Constant-Cost Industry"

II. Decreasing-Cost Industry

Exhibit 12 "Long-Run Supply in a Decreasing-Cost Industry"

III. Increasing-Cost Industry

Exhibit 13 "Long-Run Supply in an Increasing-Cost Industry"

You're The Economist: Analyze the Issue

"Recession Takes a Bite Out of Gator Profits? Applicable Concept: short-run and long-run
competitive equilibrium

Summary of Conclusion Statements

a. The large-number-of-sellers condition is met when each firm is so small relative to the total
market that not a single firm can influence the market price.
b. If a product is homogeneous, buyers are indifferent as to which seller's product they buy.
c. Perfect competition requires that resources be completely mobile to freely enter or exit a
market.
d. In perfect competition, a firm's marginal revenue equals the price that the firm views as a
horizontal demand curve.
e. In perfect competition, a firm maximizes profit or minimizes loss by producing he output where
marginal revenue equals marginal cost.
f. In perfect competition, if the price is below the minimum point on the AVC curve, each unit
produced would not cover the variable cost per unit. Therefore, the firm shuts down.
g. The long-run supply curve in a perfectly competitive constant-cost industry is perfectly elastic.
h. The long-run supply curve in a perfectly competitive decreasing-cost industry is downward
sloping.
i. The long-run supply curve in a perfectly competitive increasing-cost industry is upward sloping.

HINTS FOR EFFECTIVE TEACHING

1. Try not to get too bogged down in the graphs. Continually emphasize the common sense behind all
of this material. Otherwise, students may tend to think: "all this economics junk doesn't have
anything to do with the real world." Ask students to identify real-world markets which are
competitive.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
4 Economics for Today

2. Point out that although there are only 4 market models that this class deals with directly; in reality
there are as many differing degrees of competition as there are real-world markets. The 4-market-
model approach just tries to make things more manageable. However, almost all real-world markets
one may be interested in investigating will closely resemble one of these 4 market models.
3. Point out that it is the strength of the barriers to entry that really determines the degree of
competition in markets. That is, the strength of the barriers to entry is a distinguishing characteristic
of the 4 market structures. Those markets with fewer barriers to entry are more competitive than
markets characterized by much stronger barriers to entry.
4. You may want to add to the characteristics of the perfectly competitive market: 1) there is no non-
price competition; 2) firms are price takers. These additional characteristic criteria could be used
with the other market structures as well.
5. It may be helpful to analyze each of the 4 market environments using the following 5-step procedure
(this may help students better organize the analysis): 1) What does demand look like facing the
representative firm? 2) What is the profit-maximizing quantity of output to produce? 3) Graphically
determine the short-run profit or loss. 4) Given profits or losses what is expected to happen in this
market or industry over time (compare the short-run with the long-run)? 5) What are the pros and
cons associated with this type of market structure from society's perspective? Doing all of this for
each market structure will allow students to compare and contrast the 4 market structures.
6. The marginal revenue-marginal cost approach to maximizing profit is really an application of
marginal (or benefit-cost) analysis introduced in an earlier chapter. It may be helpful to approach it
in that way. Or, if marginal revenue exceeds marginal cost at a particular output level then the firm is
adding more to its revenues than it is to its costs. So, it is contributing positively to its total profit.
Keep producing until MR =MC. Producing beyond the profit-maximizing level would cause
marginal cost to exceed marginal revenue.
7. Other ways to state the shut-down rule (in addition to that stated in the text: if P (MR) < AVC): 1) if
losses are greater than total fixed cost, 2) if total revenue is less than total variable cost. You may
have good results with the "losses greater than TFC" approach. It is intuitive if one keeps in mind
that when a firm shuts down its losses will equal TFC. If one remains in operation and losses more
than their TFC, then naturally shut down and lose less.
8. Have students note that because there are no barriers to entry or exit then any profits or losses
experienced in the short-run will disappear in the long run (over time). Entrepreneurs will continue
to enter or leave an industry until only normal profits are earned.
9. You may find it helpful to take a few minutes and stress the pros and cons associated with the
competitive market from society's perspective: 1) P = minimum ATC implies no contribution toward
a more inequitable distribution of income as well as consumers getting the product at the cheapest
possible price, 2) P = MC implies an efficient allocation of resources. However, competitive markets
rarely promote technological progress.

CRITICAL THINKING/GROUP DISCUSSION QUESTIONS

1. If a profit-maximizing firm is producing an output level in which marginal revenue exceeds marginal
cost, should it produce more, less or the same?
Produce more until MR = MC.

2. If a profit-maximizing firm is producing an output level in which marginal revenue equals marginal
cost, then is this firm earning a profit?
We don't know. We would need to know what ATC are at that output level. Note: just because
the firm is producing the profit-maximizing or loss-minimizing output level we don't know
whether an economic profit, normal profit, or loss is incurred.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 Chapter 8: Perfect Competition 5

3. If a firm has TFC = $2,000 per day, and is currently losing $1,500 per day, should the firm shut
down?
No, because losses are less than TFC which have to be paid even if it shuts down.

4. If a firm is producing where MR =MC, and at that output level TR = $4,500, TC = $5,000, and TVC
= $4,000 per week, is the firm making or losing money? How much? Should the firm shut down?
The firm is losing $500 per week. Because its losses are less than its TFC of $1,000 per week
then the firm should remain in operation.

5. If a competitive industry is currently losing money, what can be expected to happen to the number of
sellers, the price of the product, the volume of output and losses in this industry over time?
The number of sellers will decrease, the price will rise, output will fall, and the losses will
disappear.

6. If a competitive industry expands and higher wages must be paid to attract more workers then what
will the long-run supply curve for this industry look like?
It will be upward sloping because this is an increasing-cost industry.

7. What are some barriers to entry that may prevent potential competitors from entering a market?
Threat of violence, large financial capital required to get started, technology (have to know how
to produce the product), product differentiation, sole ownership over a strategic input,
government laws and regulations, etc.

CLASSROOM GAMES

Approximately 170 non-computerized economic games (experiments) for use in the classroom are
available for free at http://www.marietta.edu/~delemeeg/games/. The following games are recommended
to help teach some of the concepts in this chapter:

Game #37—Objective: To illustrate the conditions under which entry into a market is profitable.
Game #39—Objective: To illustrate the dynamics of entry and exit in a multi-market economy.
Game #96—Objective: To illustrate the short and long run equilibrium characteristics of a competitive
market under entry and exit conditions.
Game #143—Objective: To demonstrate the long run adjustment process toward a competitive
equilibrium.
Game #167—Objective: To demonstrate the long-run equilibrium adjustment process with price-taking
firms.

ANSWERS TO: "You're the Economist: Analyze the Issue"

Recession Takes a Bite Out of Gator Profits

1. Draw short-run firm and industry competitive equilibriums for a perfectly competitive gator farming
industry before the number of alligator farms in Florida doubled. For simplicity, assume the
gator farm is earning zero economic profit. Now show the short-run effect of an increase in
demand for alligators.

As a result of the increase in the demand curve from D1 to D2, the gator farm increases its price
from P1 to P2 and earns a positive economic profit represented by the rectangle in the following

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
6 Economics for Today

graph. As a result of the recession, the demand curve shifts from D2 to D1 . prices fall from P2
toP1 and positive economic profit was eliminated.

2. Assuming gator farming is perfectly competitive, explain the long-run competitive equilibrium
condition for the typical gator farmer and the industry as a whole.

Positive economic profits attract new gator farmers to enter the industry and shift the short-run
supply curve to the right. This increase in the short-run supply curve causes the price of gator
meat to fall until economic profits reach zero in the long run. Given a U-shaped LRAC curve,
the typical gator farm will operate in long-run perfectly competitive equilibrium at the minimum
point on the long-run average cost curve.

ANSWERS TO EVEN-NUMBERED "Study Questions and Problems"

2. A Kansas wheat farmer conforms closely to the perfectly competitive market structure. There are a
large number of wheat farms, wheat is a homogeneous product, and entry or exit is not extremely
difficult.

4. See Figure 8A-2. Marginal revenue is the change in total revenue per bushel. In this case, $5 is the
marginal revenue that remains constant and equal to price.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
 Chapter 8: Perfect Competition 7

Figure 8A-2

6. A profitable firm should increase output only when its marginal revenue exceeds its marginal cost. If
the firm increases output when its marginal cost exceeds its marginal revenue, profits decline
because more is added to total cost than to total revenue.

8. (a) The firm earns an economic profit.

(b) MR2 and MR1.
(c) MR1.
(d) The firm's short-run supply curve is its marginal cost curve above the minimum point on its
AVC curve.

10. The firm can be in a loss-minimization situation. If the marginal revenue intersects the marginal cost
above the average variable cost, the firm can make the best of a bad situation by following the MR =
MC rule and producing the corresponding output, rather than shutting down. Because the marginal
revenue (price) exceeds the average variable cost, the extra revenue pays for a portion of the fixed
costs.

12. Earning economic profits attracts new truckers to the industry. This increases the short-run industry
supply curve. As a result, the price of trucking services falls, the industry quantity of output rises,
and economic profit is zero in the long run. If the payment to independent truckers rises to attract
more individuals into this business then the independent trucking industry will be an increasing-cost
industry.

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Solution Manual for Macroeconomics for Today, 9th Edition

8 Economics for Today

CHAPTER 8 SUMMARY QUIZ

1. Perfectly competitive markets are characterized by:

a. a small number of very large producers.
b. very strong barriers to entry and exit.
c. firms selling a homogeneous product.
d. all of the above.

2. Which of the following is true of a perfectly competitive firm?

a. The firm is a price maker.
b. If the firm wishes to maximize profits it will produce an output level in which total revenue
equals total cost.
c. The firm will not earn an economic profit in the long run.
d. The firm's short-run supply curve is its MC curve below its AVC curve.

3. The profit maximizing, or loss minimizing quantity of output for any firm to produce exists at that
output level in which:
a. total revenue is maximized.
b. total cost is minimized.
c. marginal cost is minimized.
d. marginal revenue equals marginal cost.

4. If a competitive firm is losing money then:

a. it should always shut down.
b. it should shut down if losses are greater than total fixed costs.
c. it should shut down if total fixed costs are greater than losses.
d. it should raise its price.

5. Which of the following is true of a perfectly competitive market?

a. If economic profits are earned then the price will fall over time.
b. In long-run equilibrium P = MR = SRMC = SRATC = LRAC.
c. A constant-cost industry exists when the entry of new firms has no effect on their cost curves.
d. All of the above.

ANSWERS TO CHAPTER 8 SUMMARY QUIZ

1. c
2. c
3. d
4. b
5. d

© 2017 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.

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