Chapter 7 Market Structure Perfect Competition Economics For Managers 3e Farnham

Economics for Managers, 3e (Farnham)
Chapter 7 Market Structure: Perfect Competition
1) As described in the text, which of the following statements best describes the strategy of many
potato growers since 2005?
A) Growers have worked together to reduce supply and stabilize demand. As a result,
equilibrium price has been propped up and allowed farmers to earn what they consider a decent
profit.
B) Growers have continued to compete vigorously with each other, causing prices and profits to
decrease.
C) Growers have restricted supply so much that there is now a severe shortage of potatoes in the
United States.
D) because efforts by potato growers to restrict supply are illegal in the United States, they have
focused exclusively on increasing demand to increase their profits.
Answer: A
Diff: 2
Topic: Potato prices
2) Which of the following is not a characteristic of perfect competition?

A) Large number of firms in the industry.
B) Outputs of the firms are perfect substitutes for one another.
C) Firms face downward-sloping demand functions.
D) No barriers to entry or exit.
Answer: C
Diff: 1
Topic: Characteristics of perfect competition
3) All of the following are characteristics of a perfectly competitive market except:

A) a large number of sellers.
B) perfectly elastic demand.
C) a homogeneous product.
D) barriers to entry.
Answer: D
Diff: 1
4) Perfectly competitive firms are said to be "small." Which of the following best describes this
smallness?
A) The individual firm must have fewer than 10 employees.
B) The individual firm faces a downward-sloping demand curve.
C) The individual firm has assets of less than $2 million.
D) The individual firm is unable to affect market price through its output decisions.
Answer: D
Diff: 2
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5) The market structure that is most different from the model of perfect competition is:
A) monopolistic competition.
B) monopsony
C) oligopoly.
D) monopoly.
Answer: D
Diff: 2
Topic: Market structures
6) Consumers don't care which supplier they buy from in a perfectly competitive market because:
A) the outputs of the firms in a perfectly competitive market are all the same.
B) the consumers have no choice regarding who they buy from.
C) price is always low enough that the choice of supplier doesn't matter.
D) all of the above.
Answer: A
Diff: 2
7) The manager of a perfectly competitive firm has to decide:

A) the quantity of output the firm should produce.
B) the price the firm should charge for its output.
C) the quantity of output the firm should produce and the price it should charge.
D) neither the quantity of output the firm should produce nor the price it should charge because
the market makes both of these decisions.
Answer: A
Diff: 2
8) The demand curve faced by the individual perfectly competitive firm is:
A) downward sloping.
B) upward sloping.
C) horizontal.
D) vertical.
Answer: C
Diff: 1
9) The demand curve faced by the individual perfectly competitive firm is:
A) perfectly elastic.
B) perfectly inelastic.
C) unit elastic.
D) elastic or inelastic depending on price.
Answer: A
Diff: 1
10) Which of the following statements regarding a price-taking firm is correct?
2
A) Demand = average revenue > marginal revenue.
B) Demand = marginal revenue > average revenue.
C) Demand = price = average revenue = marginal revenue.
D) Demand = price > average revenue > marginal revenue.
Answer: C
Diff: 1
11) Which of the following statements is correct?

A) Economic profit is the difference between total revenue and the full opportunity cost of all the
resources used in production.
B) Economic profit is the difference between total revenue and explicit costs.
C) Economic profit is generally greater than accounting profit.
D) Economic profit is the difference between total revenue and implicit costs.
Answer: A
Diff: 1
Topic: Economic versus accounting profit
12) In order to maximize its profits, a price-taking firm should produce the level of output at
which:
A) total revenue = total cost.
B) average revenue = average cost.
C) variable revenue = variable cost.
D) marginal revenue = marginal cost.
Answer: D
Diff: 1
Topic: Profit maximization
13) Marginal revenue is equal to:

A) the change in price divided by the change in output.
B) the change in quantity divided by the change in price.
C) the change in P x Q due to a one unit change in output.
D) price, but only if the firm is a price searcher.
Answer: C
Diff: 2
Topic: Marginal revenue
14) In the case of the perfectly competitive firm:

A) marginal revenue equals the market price.
B) marginal revenue is greater than the market price.
C) marginal revenue is less than the market price.
D) marginal revenue is equal to, less than, or greater than market price depending on the level of
output.
Answer: A
Diff: 1
3
15) Assume a perfectly competitive firm is producing a level of output at which MR < MC. What
should the firm do to maximize its profits?
A) The firm should do nothing — it wants to maximize the difference between MR and MC in
order to maximize its profits.
B) The firm should decrease output.
C) The firm should increase price.
D) The firm should increase output.
Answer: B
Diff: 2
16) Assume a perfectly competitive firm is producing a level of output at which MR < MC. What
will happen as the firm moves to its profit-maximizing equilibrium?
A) Marginal revenue will rise.
B) Marginal revenue will fall.
C) Marginal cost will rise.
D) Marginal cost will fall.
Answer: D
Diff: 2
17) The perfectly competitive firm:

A) makes its profit-maximizing decision only on the basis of output.
B) faces a downward-sloping demand function.
C) can influence market price only in a downward direction.
D) cannot earn any economic profits because it faces a horizontal demand curve.
Answer: A
Diff: 2
18) Assume at the firm's profit-maximizing level of output P = AVC. In this case, the firm will
be:
A) earning a positive economic profit.
B) earning economic profit = 0.
C) incurring an economic loss.
D) breaking even.
Answer: C
Diff: 2
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19) When a firm is producing at the profit maximizing level of out put and P > ATC, the firm is:
A) breaking even.
B) incurring an economic loss.
C) earning an economic profit.
D) earning a profit or incurring a loss depending on the level of total fixed costs.
Answer: C
Diff: 2
Topic: Economic profit
20) A firm encounters its "shutdown point" when:

A) average total cost equals price at the profit-maximizing level of output.
B) average variable cost equals price at the profit-maximizing level of output.
C) average fixed cost equals price at the profit-maximizing level of output.
D) marginal cost equals price at the profit-maximizing level of output.
Answer: B
Diff: 1
Topic: Shutdown point
21) A perfectly competitive firm will minimize its losses by shutting down when:
A) P < AVC at the profit-maximizing level of output.
B) P < ATC at the profit-maximizing level of output.
C) P < MC at the profit-maximizing level of output.
D) P < TFC at the profit-maximizing level of output.
Answer: A
Diff: 2
22) When price is less than average variable cost at the profit-maximizing level of output, a firm
should:
A) continue to produce the level of output at which marginal revenue equals marginal cost if it is
operating in the short run.
B) continue to produce the level of output at which marginal revenue equals marginal cost if it is
operating in the long run.
C) shutdown, because it will lose nothing in that case.
D) shutdown, because it cannot even cover all of its variable costs let alone its fixed costs if it
stays in business.
Answer: D
Diff: 2
5
23) When price is greater than average variable cost but less than average total cost at the profit-
maximizing level of output, a firm should:
A) continue to produce the level of output at which marginal revenue equals marginal cost.
B) increase output to minimize its losses.
C) reduce output to the level at which price equals average variable cost to minimize its losses.
D) shutdown to minimize its losses.
Answer: A
Diff: 2
24) Widgets R Us, which is a price-taking firm, is currently producing 250 units of output. The
market price is $3 per unit, the marginal cost of the 250th unit is $2.75, average total cost is
$3.50 per unit, and average variable cost is $2.50 per unit. What advice should you give Widgets
R Us?
A) Increase output to reduce losses.
B) Continue to produce 250 units in the short run.
C) Shut down to minimize losses.
D) Decrease output to 200 units.
Answer: A
Diff: 3
25) Assume that at the current market price, a perfectly competitive firm's profit-maximizing
level of output yields total revenues that are just equal to total costs. Which of the following
statements applies to this firm?
A) The firm should shut down right now.
B) The firm should continue to operate in the short run to minimize losses, but shut down if
things don't improve over the long run.
C) The firm is earning zero economic profit and should continue to operate.
D) The firm should increase its explicit costs to reduce its tax burden.
Answer: C
Diff: 2
26) By shutting down when price is less than average variable cost at the profit-maximizing level
of output, a perfectly competitive firm will limit its losses to its:
A) total variable costs.
B) total costs.
C) total fixed costs.
D) marginal costs.
Answer: C
Diff: 2
Topic: Minimizing losses
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27) Which of the following statements is definitely true when price is less than average total cost
for a firm producing the profit-maximizing level of output in the short run?
A) The firm is running a loss in an accounting sense, so that total revenue is less than total
explicit costs.
B) The firm will minimize its losses by shutting down.
C) The firm will be earning negative total revenue.
D) The firm is incurring an economic loss.
Answer: D
Diff: 2
28) By continuing to operate when price is greater than average variable cost but less than
average total cost, a firm limits its losses to:
A) $0.
B) its total fixed costs.
C) the difference between its total fixed cost and the amount by which total revenue exceeds total
variable costs.
D) its total variable costs.
Answer: C
Diff: 3
Topic: Minimizing losses
29) Assume a perfectly competitive firm is producing 300 units of output, P = $10, ATC of the
300th unit is $8, marginal cost of the 300th unit = $10, and AVC of the 300th unit = $6. Based
on this information, the firm is:
A) earning an economic profit of $600.
B) earning an economic profit of $1,200.
C) incurring a loss of $600.
D) incurring a loss of $1,200.
Answer: A
Diff: 2
Topic: Calculating profits and losses
500th unit is $6, marginal cost of the 500th unit = $7, and AVC of the 500th unit = $5. Based on
this information, the firm is:
B) earning an economic profit of $1,000.
C) incurring a loss of $500.
D) incurring a loss of $1,000.
Answer: A
Diff: 2
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300th unit is $11, marginal cost of the 300th unit = $10, and AVC of the 300th unit = $9. Based
on this information, the firm is:
B) earning an economic profit of $600.
C) incurring a loss of $300 and should shut down.
D) incurring a loss of $300, but should continue to operate in the short run.
Answer: D
Diff: 2
32) A perfectly competitive firm will maximize profits (or minimize losses) so long as price
(marginal revenue) is:
A) greater than marginal cost.
B) greater than average fixed cost.
C) greater than average total cost.
D) greater than average variable cost.
Answer: D
Diff: 2
33) The perfectly competitive firm's supply curve:

A) coincides with its perfectly elastic demand curve.
B) is perfectly inelastic at the market price.
C) is the firm's marginal cost curve above the minimum point on the AVC curve.
D) is the firm's average total cost curve above the shutdown point.
Answer: C
Diff: 1
Topic: Supply in perfect competition
34) Assume that as the firms in a perfectly competitive industry expand output, the prices of
productive inputs increase. All else constant, this would cause the individual firms' marginal cost
curves to ________ and the market supply curve to become ________.
A) shift down; flatter
B) shift down; steeper
C) shift up; flatter
D) shift up; steeper
Answer: D
Diff: 3
Topic: Supply in perfect competition
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35) Which of the following is not an option for a perfectly competitive firm in the short run?
A) Increase its level of production.
B) Decrease its level of production.
C) Shut down.
D) Exit the market altogether.
Answer: D
Diff: 2
36) If a market is perfectly competitive and is in long-run equilibrium, which of the following
conditions does not hold?
A) Price is equal to the minimum long-run average cost of production.
B) Economic profit equals zero.
C) The value of the last unit of output produced is equal to the value of the resources used to
produce it.
D) There is an incentive for additional firms to enter the market because existing firms are
earning revenues in excess of the explicit costs of production.
Answer: D
Diff: 2
Topic: Perfect competition and long-run equilibrium
37) When a perfectly competitive firm is in long-run equilibrium:

A) its total revenues equal the sum of its total explicit and implicit costs costs.
B) the firm is operating at the minimum of its LRAC curve.
C) the firm is earning zero economic profit.
D) All of the above.
Answer: D
Diff: 1
Topic: Long-run equilibrium in perfect competition
38) Assume there is a decrease in the market demand for a good sold by price-taking firms that
are initially producing the profit-maximizing level of output. For the individual firm, this would
result in:
A) a decrease in both price and the profit-maximizing quantity of output.
B) a decrease in price and increase in the profit-maximizing quantity of output.
C) an increase in both price and the profit-maximizing quantity of output.
D) an increase in price and decrease in the profit-maximizing quantity of output.
Answer: A
Diff: 2
Topic: Change in demand and profit maximization
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39) Assume there is a decrease in the market demand for a good sold by price-taking firms that
are initially producing the profit-maximizing level of output. How will the market adjust over
time?
A) Firms will enter the market, causing price to rise until losses are eliminated.
B) Firms will enter the market, causing price to fall until positive profits are eliminated.
C) Firms will exit the market, causing price to rise until losses are eliminated.
D) Firms will exit the market, causing price to fall until positive profits are eliminated.
Answer: C
Diff: 2
Topic: Adjustment to long-run equilibrium
40) Assume there is an increase in the number of consumers in the market for a good sold by
perfectly competitive firms that are initially producing the profit-maximizing level of output. For
the individual firm, this would result in:
A) a decrease in both price and the profit-maximizing quantity of output.
B) a decrease in price and increase in the profit-maximizing quantity of output.
C) an increase in both price and the profit-maximizing quantity of output.
D) an increase in price and decrease in profit-maximizing quantity of output.
Answer: C
Diff: 2
41) Assume there is an increase in demand in a perfectly competitive market that was initially in
long-run equilibrium. Which of the following statements is false?
A) Consumers have shown that they now consider the good to be more valuable.
B) In the short run, profits will be lower than normal.
C) Resources from other industries will be attracted into the market.
D) Over time, the market supply curve will shift right.
Answer: B
Diff: 2
42) If farmers operating in the competitive wheat industry are incurring losses, and are not kept
in business with government subsidies, which of the following will result?
A) Price and quantity produced will both increase in the long run.
B) Resources will be reallocated out of the wheat industry into more productive uses.
C) Farmers will run economic losses indefinitely, if they are rational.
D) The supply of wheat will fall to near zero and the U.S. will become dependent on foreign
suppliers of food.
Answer: B
Diff: 2
Topic: Economic losses
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43) Assume a perfectly competitive firm is in long-run equilibrium and there is a decrease in
market demand for the firm's output. Which of the following will occur?
A) Existing firms will maintain the original level of output, but they will shift their cost functions
down in the short run.
B) Existing firms will raise price to cover the reduction in quantity demanded and maintain total
revenue in the short run.
C) Existing firms will reduce output in the short run.
D) Market price will be above its original level.
Answer: C
Diff: 2
44) Assume the firms in a perfectly competitive industry are initially in long-run equilibrium and
the cost of labor increases. In the short run, this will cause firms in the industry to:
A) reduce output and incur a loss.
B) reduce output and earn a positive economic profit.
C) increase output and incur a loss.
D) increase output and earn a positive economic profit.
Answer: A
Diff: 2
Topic: Change in costs and profit maximization
45) Assume the firms in a perfectly competitive industry are initially in long-run equilibrium and
the cost of labor increases. How will the market adjust over time?
A) Firms will enter the market, causing price to rise until losses are eliminated.
B) Firms will enter the market, causing price to fall until positive profits are eliminated.
C) Firms will exit the market, causing price to rise until losses are eliminated.
D) Firms will exit the market, causing price to fall until positive profits are eliminated.
Answer: C
Diff: 2
46) Assume that goods X and Y are substitutes and are produced in perfectly competitive
markets. All else constant, in the short run, a decrease in the supply of good X would cause:
A) an increase in the demand for good Y.
B) a decrease in the demand for good Y.
C) an increase in the supply of good Y.
D) a decrease in supply of good Y.
Answer: A
Diff: 2
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47) Assume that goods X and Y are substitutes and are produced in perfectly competitive
markets. If there is a decrease in the supply of good X, which of the following will happen in the
market for good Y in the long run?
A) Firms will exit, causing market price to rise.
B) Firms will enter, causing market price to fall.
C) Price will be higher at the new long-run equilibrium as a result of entry into the market.
D) The firms that were already in the industry will continue to earn positive economic profit.
Answer: B
Diff: 2
48) Suppose a perfectly competitive firm, which is initially in long-run equilibrium experiences a
decrease in the wages it must pay its employees. In the short run, which of the following will
occur?
A) ATC will shift up and MC will shift down, causing the firm to incur a loss.
B) ATC will shift down and MC will shift up, causing the firm to earn a positive economic
profit.
C) ATC and MC will shift down, causing the firm to earn a positive economic profit.
D) ATC and MC will shift up, causing the firm to incur a loss.
Answer: C
Diff: 2
49) Industry X, which is perfectly competitive, is in long-run equilibrium. Assume a new law is
passed that requires employers in industry X to provide health insurance to previously uninsured
employees. As a result of this new requirement we would expect to observe:
A) a decrease in price and an increase in total output in industry X.
B) a decrease in price and total output in industry X.
C) an increase in price and a decrease in total output in industry X.
D) an increase in price and total output in industry X.
Answer: C
Diff: 3
50) Assume that there is an improvement in the technology used by firms in a perfectly
competitive industry that is initially in long-run equilibrium. In the short run this would cause:
A) an increase in the firm's economic profit.
B) a decrease in the firm's economic profit.
C) no change in the firm's economic profit.
D) cannot be determined with the information given.
Answer: A
Diff: 2
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51) Industry Y is a perfectly competitive industry. Assume that as a result of changes in other
markets there is a twenty percent increase in the price of variable inputs used by firms in industry
Y. After all adjustments have taken place, we would expect the equilibrium price in industry Y
to:
A) decrease and the number of firms to increase.
B) decrease and the number of firms to decrease.
C) increase and the number of firms to increase.
D) increase and the number of firms to decrease.
Answer: D
Diff: 2
52) Assume goods X and Y are complements and are produced in perfectly competitive markets.
All else constant, an increase in demand for good X would cause:
A) a decrease in the number of firms that produce good X.
B) an increase in the number of firms that produce good Y.
C) a decrease in the number of firms that produce good Y.
D) no effect on the number of firms that produce either good.
Answer: B
Diff: 3
53) Suppose a perfectly competitive firm is in long-run equilibrium and there is a decrease in
demand. Suppose also that the firm operates in an industry in which the prices of productive
inputs vary with the level of output, increasing when output increases and decreasing when
output decreases. Which of the following will occur at the new long-run equilibrium?
A) Price will be lower than it was at the initial long-run equilibrium.
B) Price will be the same as it was at the initial long-run equilibrium.
C) Price will be higher than it was at the initial long-run equilibrium.
D) The industry supply function will shift to the right.
Answer: A
Diff: 3
54) What is the "most efficient capacity" for the perfectly competitive firm?
A) The plant size at which LRAC is at its minimum.
B) The plant size at which any of the SRATC curves are tangent to the LRAC curve.
C) The plant size at which MR = MC.
D) The plant size for which Price = AR.
Answer: A
Diff: 1
Topic: Efficient capacity
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55) When a perfectly competitive market has fully adjusted to demand and supply conditions, all
of the following are true except:
A) P = MC.
B) P = the minimum of SRATC.
C) P = the minimum of LRAC.
D) P = the minimum of AVC.
Answer: D
Diff: 2
Topic: Long-run equilibrium
56) The term "industry concentration":

A) refers to the degree of product differentiation in an industry.
B) is a measure of how many firms produce the total output of an industry.
C) refers to how capital or labor intensive a particular industry is.
D) is a measure of how many customers purchase the total output of an industry.
Answer: B
Diff: 1
Topic: Industry concentration
57) Which of the following statements regarding the agricultural industry is correct?
A) Economies of scale and consolidation have significantly reduced the degree of competition in
the industry.
B) Corporate farms now control more than 50 percent of the market for each of the major crops.
C) The largest 5 percent of growers of any particular product are characterized by a small
number of interdependent producers.
D) Although farming has become increasingly concentrated over the last 70 years, it is still a
highly competitive industry.
Answer: D
Diff: 1
Topic: Agricultural industry
58) Which of the following is not a characteristic of the broiler chicken industry?
A) A significant degree of industry concentration, with the four largest firms producing 40
percent of the industry's output.
B) A significant degree of real and subjective product differentiation.
C) An inability of individual firms to have any influence market price.
D) A significant amount of advertising.
Answer: C
Diff: 2
Topic: Broiler chicken industry
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59) As the level of competition in an industry increases, the price-cost margin approaches:
A) 0.
B) 1.
C) 10.
D) infinity.
Answer: A
Diff: 2
Topic: Price-cost margin
60) Which of the following statements regarding the trucking industry is correct?
A) The recession of 2007 -2009 caused many trucking firms to exit with many firms filing for
bankruptcy.
B) The trucking industry most closely resembles an oligopoly.
C) Even though there is a high degree of competition, firms in the trucking industry are able to
sustain positive economic profits as a result of a substantial degree of product differentiation.
D) The trucking industry was largely unaffected by the recession of 2007-2009 mainly because
the industry is comprised by large firms with significant market power.
Answer: A
Diff: 2
Topic: Trucking industry
61) The elasticity of supply is measured by:

A) the quantity supplied divided by price.
B) the change in quantity supplied divided by the change in price.
C) the percentage change in quantity supplied divided by the percentage change in quantity
demanded.
D) the percentage in quantity supplied divided by the percentage change in price.
Answer: D
Diff: 1
Topic: Elasticity of supply
62) Assume the elasticity of of supply for a particular good has been estimated to equal 1.8. In
this case, a 10 percent increase in product price would cause the quantity supplied to:
A) decrease by 1.8 percent.
B) increase by 1.8 percent.
C) decrease by 18 percent.
D) increase by 18 percent.
Answer: D
Diff: 2
Topic: Elasticity of supply
63) As the case study in the text illustrates, individual firms in the potato industry have a great
deal of market power.
Answer: FALSE
Diff: 1
Topic: Potato industry
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64) A perfectly competitive market is characterized by a large number of small firms that
produce a differentiated product.
Answer: FALSE
Diff: 1
65) The characteristic of ease of entry and exit ensures that perfectly competitive firms will be
able to earn positive economic profits over the long run.
Answer: FALSE
Diff: 2
66) Perfectly competitive firms are referred to as price takers because the individual firm is so
small relative to the market that its output decisions will not have any effect on the market-
determined price.
Answer: TRUE
Diff: 1
67) The elasticity of demand for a particular perfectly competitive firm's output is positively
related to the number of firms supplying the market.
Answer: FALSE
Diff: 2
68) The individual firm maximizes its total profit by producing the level of output at which the
difference between marginal revenue and marginal cost is as large as possible.
Answer: FALSE
Diff: 1
69) Assume that at the current level of output produced by a perfectly competitive firm, MR =
$7.50 and MC = $6. In order to maximize its profit, the firm should increase output.
Answer: TRUE
Diff: 2
70) A perfectly competitive firm will earn a positive economic profit so long as price is greater
than average total cost at the profit-maximizing level of output.
Answer: TRUE
Diff: 1
Topic: Economic profit
71) A firm has reached its shutdown point when price is equal to minimum average total cost.
Answer: FALSE
Diff: 1
16
72) Assume that at the current level of output, price equals marginal revenue, but is less than
average total cost. So long as price is greater than average variable cost, the firm should continue
to operate in the short run to minimize its losses.
Answer: TRUE
Diff: 2
73) When a firm decides to shut down in the short run, its losses are limited to its fixed costs.
Answer: TRUE
Diff: 1
Topic: Shutdown point and losses
74) Assume a firm is currently producing 800 units of output, P = $10, MC = $10, ATC = $8,
and AVC = $6. In this case, the firm is maximizing its profit, which equals $1,600.
Answer: TRUE
Diff: 2
75) Assume a firm is facing the following situation: At Q = 1,000, P = $10, MC = $10, ATC =
$18, and AVC = $16. This firm should shut down and, in so doing, limit its losses to $2,000.
Answer: TRUE
Diff: 2
76) The perfectly competitive firm's supply curve is that portion of the marginal cost curve that
lies above the firm's average total cost curve.
Answer: FALSE
Diff: 1
Topic: Perfectly competitive supply
77) If the level of output produced by the firms in a perfectly competitive market has no effect on
the prices of the inputs used by the firms, the market supply curve will be flatter than the supply
curve for an individual firm in the market.
Answer: TRUE
Diff: 2
Topic: Perfect competition and market supply
78) In the short run, a perfectly competitive firm can earn positive, zero, or negative profit
depending on the market price of the firm's output.
Answer: TRUE
Diff: 1
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79) In the model of the perfectly competitive firm, the firm's fixed costs are equal to its implicit
costs of production.
Answer: FALSE
Diff: 2
Topic: Implicit versus explicit costs
80) Assume the market price is greater than average total cost at the perfectly competitive firm's
profit-maximizing level of output. In this case, the firm is earning positive economic profits,
which act as an incentive for new firms to enter the market.
Answer: TRUE
Diff: 2
Topic: Economic profit and entry
81) When the firms in a perfectly competitive market are incurring economic losses, some of the
firms will exit the market, causing the supply curve to shift left and market price to rise until
losses incurred by the remaining firms are eliminated.
Answer: TRUE
Diff: 2
Topic: Economic losses and exit
82) Assume there is a decrease in the supply of a product produced in a perfectly competitive
market. All else constant, in the short run this will cause the profits of firms that produce
substitutes for the good in question to increase.
Answer: TRUE
Diff: 3
83) Assume the firms in a perfectly competitive market are initially incurring economic losses.
An increase in supply would cause existing firms' economic losses to decrease.
Answer: FALSE
Diff: 2
Topic: Change in supply and profit maximization
84) Although an improvement in technology enables perfectly competitive firms to earn a

positive economic profit in the short run, entry by new firms will ensure that those profits are
eliminated over time.
Answer: TRUE
Diff: 2
85) When a perfectly competitive market is in long-run equilibrium, price is equal to marginal
cost, the individual firm is operating at the minimum of its short-run and long-run average cost
curves, and economic profit equals zero.
Answer: TRUE
Diff: 1
Topic: Long-run equilibrium in perfect competition
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86) Because two percent of the largest farms grow half of all of the grain in the United States, the
grain industry is technically classified as an oligopoly.
Answer: FALSE
Diff: 2
Topic: Agricultural industry
87) The estimated price-cost margin of 11.9 percent in the market for broiler chickens in 1992
suggested that there was a high degree of competition in that industry.
Answer: TRUE
Diff: 1
Topic: Broiler chicken industry
88) There is an inverse relationship between the price-cost margin and the level of competition in
a particular industry.
Answer: TRUE
Diff: 2
Topic: Price-cost margin
89) The larger firms in the red-meat industry have blunted the effects of competition by relying
on product differentiation, which in effect, creates a downward-sloping demand curve for each
firm's product.
Answer: TRUE
Diff: 3
Topic: Red-meat industry
90) If firms in a perfectly competitive industry produce an undifferentiated product, it is not

possible to increase profits of the individual firms in the industry by increasing market demand
for the product because of the large number of available substitutes.
Answer: FALSE
Diff: 2
91) Between 1999 and 2007, the behavior of firms in the trucking industry closely matched the
outcome predicted by the model of perfect competition.
Answer: TRUE
Diff: 1
92) High fuel prices and losses by smaller firms have resulted in a considerable amount of
consolidation in the trucking industry, which now most closely resembles the oligopoly market
structure.
Answer: FALSE
Diff: 1
19
93) Assume the price elasticity of supply for grade wheat has been estimated to be +0.82. This
means that when the price of wheat increases by 10 percent, the quantity of wheat supplied to the
market increases by 82 percent.
Answer: FALSE
Diff: 2
Topic: Price elasticity of supply
94) When the percentage change in quantity supplied is greater than the percentage change in
price, supply is said to be elastic.
Answer: TRUE
Diff: 1
95) Because of the large number of firms that operate in the agricultural industry, the supply of
agricultural products is inelastic over the entire range of output.
Answer: FALSE
Diff: 2
96) Summarize the characteristics of a perfectly competitive market.

Answer: A perfectly competitive firm produces a product that is identical to that of its
competitors, the number of competitors is large and each individual producer is small relative to
the market, there is ease of entry into the market, and market participants have perfect
information. Perfectly competitive firms are price takers.
Diff: 1
97) What assumptions in the perfect competition model ensure that economic profit is zero in the
long run? Explain.
Answer: The assumptions that 1) market participants have perfect (complete) information and 2)
there are no barriers to entry ensure that long-run profits will equal zero in a perfectly
competitive market. So long as economic profits (losses) exist, firms will enter (leave) the
market. Only when long-run profit equals zero will there be no more incentive for entry or exit.
The assumption of perfect information ensures that each firm has access to the least-cost method
of production. As such, one firm cannot have a cost advantage over other firms in the market.
Diff: 2
Topic: Perfect competition and economic profit
20
98) Explain why a firm maximizes its profits by producing the level of output at which marginal
revenue equals marginal costs.
Answer: Profit is equal to the difference between total revenue and total cost. Marginal revenue
is the addition to total revenue when an additional unit of output is produced and sold. Marginal
cost is the addition to total cost when an additional unit of output is produced. So long as MR >
MC, more is added to total revenue than is added to total cost. As such, the difference between
total revenue and total cost, i.e., profit, increases. When MR < MC, more is added to total cost
than is added to total revenue. In this case, the difference between total revenue and total cost,
i.e., profit, decreases.
Diff: 2
99) Explain why a firm should continue to operate in the short run so long as market price is
greater the the firm's average variable cost at the profit-maximizing level of output.
Answer: So long as market price is greater than average variable cost at the profit-maximizing
level of output, the firm's total revenues will be greater than its total variable costs. Thus, the
firm will be able to pay all of its variable costs and have some amount of money left over to pay
part of its fixed costs. If the firm decided to shut down it would have to pay all of its fixed costs
out of pocket. This amount is clearly greater than the loss it incurs if it continues to operate.
Diff: 2
100) Assume the market for a good produced by perfectly competitive firms is currently in
equilibrium (economic profit = 0). Now assume there is a decrease in market demand for the
good. Analyze the short-run effects of the decrease in demand on equilibrium market price and
output. What has happened to the profits of each of the firms in the industry? Over time, what
will happen to the number of firms in the industry? Why?
Answer: In the short run, the decrease in market demand, which is illustrated graphically by a
leftward shift of the market demand curve, will cause market price and output to decrease. This
will result in losses for existing firms, since price will fall below the average total costs of
production. Over time, some of the firms in the industry will leave, causing market supply to
decrease (shift left) and market price to rise until the remaining firms are once again earning zero
economic profit and there is no more incentive for firms to exit the market.
Diff: 2
21
101) Assume a perfectly competitive firm is currently producing 5,000 units of output and is
earning $15,000 in total revenue. The marginal cost of the 5,000th unit of output is $3. The
corresponding average total cost is $3.50 and total fixed costs equal $1250. Based on this
information, should this firm continue to operate in the short run? Why or why not?
Answer: No, the firm should not continue to operate and should instead shut down. Based on the
information in the question, market price (and marginal revenue) equals $3 ($15,000/5,000). In
addition, average fixed cost equals $0.25 ($1250/5000). As such the firm's average variable cost,
which is equal to the difference between average total cost and average fixed cost, equals $3.25.
Because price is less than AVC at the profit-maximizing (in this case loss-minimizing) level of
output, the firm will minimize its losses by shutting down.
Diff: 3
102) Fill in the blanks to complete the following statements.

"Assume a perfectly competitive market is initially in long-run equilibrium. In the short run, a
decrease in raw materials prices will cause the firm's average costs to ________. As a result, the
profits of existing firms will ________. However, over the long run, this will cause the number
of firms in the market to ________, and market price will ________ until firms once again earn a
________."
Answer: decrease; increase; increase; decrease; zero economic profit
Diff: 2
Topic: Change in supply and perfect competition
22
103) Use the following pair of graphs, which illustrate the market for corn (which is used to
produce corn-based ethanol) and a representative firm, to answer the following questions.
Figure 7.1
a. Assume policymakers pass a law requiring that all gas sold in the United States contain at least
10 percent corn-based ethanol. In the graphs above, illustrate the short-run effects of this law. In
particular, show how the law would affect
• the short-run equilibrium in the market for corn,
• the short-run demand curve faced by the representative firm, and
• the representative firm's short-run profit-maximizing level of output.
Label the new curves and equilibrium values using a subscript 2.
b. Next, graphically illustrate how, after the initial changes you illustrated in question 7, the corn
market and the representative firm would adjust back to long-run equilibrium. Label any new
curves and equilibrium values using a subscript 3. After all adjustments have taken place, what
has happened to the equilibrium market price, the number of firms operating in the market, and
the representative firm's profits? Why?
Answer:
a. The new market demand curve will shift to the right of the original demand curve, causing
market price and output to increase. This will cause the demand curve faced by the firm to shift
up to the new higher equilibrium price. As such, existing firms will increase output and earn a
positive economic profit.
b. The number of firms will increase. This will cause industry supply curve to shift right. The
new supply curve intersects D2 at P1 and a level of output greater than QM. In addition, firms
will once again be earning an economic profit = 0.
Diff: 2
23
104) Assume the government decides to impose a per-unit tax on a good produced in a perfectly
competitive market.
a. Graphically illustrate the short-run effects of the tax on the cost conditions faced by a
representative firm in the market.
b. Explain the adjustment process to long-run equilibrium in the market. What has happened to
long-run equilibrium price and output as a result of the tax? What has happened to the number of
firms in the market? Why?
Answer:
a. The per unit tax would cause the individual firm's cost curves to shift up by the amount of the
tax.
b. Assuming the firms in the market were initially in long-run equilibrium, at the initial
equilibrium market price firms would now be incurring losses. Over time, some firms would exit
the market, causing market supply to decrease (the market supply curve would shift left), and
market price to increase until losses are eliminated. Overall, the number of firms in the market
would decrease.
Diff: 3
105) Assume the production technology changes for a good that is currently produced in a
perfectly competitive market. In particular, the new technology is such that the marginal costs of
production for a single firm decline over the entire range of the demand curve for the good in
question. How would this affect the number of firms that operate in this market? Explain.
Answer: Eventually, one firm would control the entire market. This would result from increases
in capacity by firms attempting to lower costs and therefore earn economic profits in the short
run. Firms that expand would be able to sell their output at a lower price and still earn a normal
profit (or possibly economic profit). Other firms would be forced to expand or leave the market.
Expansion of plant capacity by some firms and exit by others would continue until only one firm
was left in the market.
Diff: 3
24
106) Explain why, when all adjustment have taken place, the perfectly competitive firm will
operate at the minimum of its short-run and long-run average total cost curves and earn zero
economic profit.
Answer: Because perfectly competitive firms are price takers, the only means they have to
increase profits in the short run is by reducing their costs of production. As such, in the short run,
the individual firm will do what it can to use its current scale of operation as efficiently as
possible by operating at the minimum of its short-run average cost curve. This same incentive
will also induce firms to exploit any economies of scale in production. So long as economies of
scale exist, individual firms will expand their scale of production to lower their average costs
relative to price and, in so doing, increase profits. However, the assumption of perfect
information means that every firm will move to the minimum of the long-run average cost curve.
In addition, entry or exit will continue until firms are earning zero economic profit and there is
no more incentive for entry into or exit from the industry by individual firms.
Diff: 2
Topic: Long-run equilibrium and perfect competition
25

Chapter 7 Market Structure Perfect Competition Economics For Managers 3e Farnham

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Chapter 7 Market Structure Perfect Competition Economics For Managers 3e Farnham

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Economics for Managers, 3e (Farnham)

Chapter 7 Market Structure: Perfect Competition

2) Which of the following is not a characteristic of perfect competition?

3) All of the following are characteristics of a perfectly competitive market except:

7) The manager of a perfectly competitive firm has to decide:

10) Which of the following statements regarding a price-taking firm is correct?

11) Which of the following statements is correct?

13) Marginal revenue is equal to:

14) In the case of the perfectly competitive firm:

17) The perfectly competitive firm:

20) A firm encounters its "shutdown point" when:

33) The perfectly competitive firm's supply curve:

37) When a perfectly competitive firm is in long-run equilibrium:

56) The term "industry concentration":

61) The elasticity of supply is measured by:

84) Although an improvement in technology enables perfectly competitive firms to earn a

90) If firms in a perfectly competitive industry produce an undifferentiated product, it is not

96) Summarize the characteristics of a perfectly competitive market.

102) Fill in the blanks to complete the following statements.

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