Perfect Competition Review Problems

If the price of its product falls below the minimum point on the AVC curve, the best a perfectly competitive firm can do is to

• shut down and incur a loss equal to its total variable cost

• shut down and incur a loss equal to its total fixed cost

• keep producing and incur a loss equal to its total variable cost

• keep producing and incur a loss equal to its total fixed cost

Answer explanation

Shut-down rule: the firm must shut down when it can't cover its variable costs. It has already paid fixed cost, so that is its loss

Based on the table which shows Chip's costs, if rice sells for $600 a ton, Chip's

profit-maximizing output is

• less than one ton

• between one and two tons

• between two and three tons

• between three and four tons

Answer explanation

MC = $600 = MR at an output level of 3 tons

Based on the table which shows Chip's costs, if rice sells for $600 a ton, Chip will

• stay open because he earns an economic profit

• stay open because the price is above his minimum average variable cost

• shut down because the price is below his minimum average variable cost

• shut down because he incurs an economic loss

Answer explanation

At an output of 3 tons, MR=MC but Chip is taking a loss of $400 since TR is $1800 but TC is $2200. However, Chip will still operate in the short run because his revenue is greater than his variable cost, which is $1200 ($2200 - the $1000 fixed cost)

In the above figure, if the price is P1, the firm will produce

• where ATC equals P1

• where MC equals P1

• nothing

• where MC equals ATC

Answer explanation

P1 is the firm's MR. Firms produce the amount where MR=MC

In the figure, if the firm increases its output from Q1 to Q2, it will

• increase its profit

• reduce its marginal revenue

• decrease its profit

• increase its marginal revenue

Answer explanation

Q2 is where MR = MC, so profit is maximized at Q2.

(profit per unit is higher at Q2, but not total profit)

In the above figure, if the price is P1, the firm is

• incurring an economic loss

• shut down

• breaking even

• making an economic profit

Answer explanation

P > ATC at Q2, so the firm is making profit on each unit.

In the above figure, if the firm produced Q1, the firm's economic profit is ________ than if it produced Q2 and ________ than if it produced Q3

• more; less

• less; more

• more; more

• less; less

Answer explanation

Profit is maximized at Q2 since that is where MR=MC, so profit is less at Q1 than Q2. Profit is greater at Q1 than at Q3 because at Q1, the price is greater than Average Total Cost (positive profit), and at Q3 the price equals Average Total Cost (zero profit).

A perfectly competitive firm will have an economic profit of zero if, at its profit-maximizing output, its marginal revenue equals its

• marginal cost

• average variable cost

• average total cost

• average fixed cost

Answer explanation

(P - ATC) equals profit per unit, so if P = ATC, profit per unit is zero and total economic profit is zero

The figure above shows short-run cost curves for a perfectly competitive firm. If the price of the

product is $8, in the short run the firm will

• incur an economic loss

• earn an economic profit

• earn a normal profit

• more information is needed to determine the

  firm's profit or loss

Answer explanation

When P = MC = $8, P < ATC so profit per unit is negative

If there are 1,000 rutabaga farms, all perfectly competitive, an increase in the price of fertilizer used for growing rutabagas will

• have no effect on the total quantity of rutabagas supplied, because each farm's supply curve is

  a vertical line

• reduce the total quantity of rutabagas supplied, because each farm's supply curve is a

  horizontal line and will shift upward

• have no effect on the total quantity of rutabagas supplied, because no farm has enough market

  power to raise the price

• decrease the total quantity of rutabagas supplied, because each farm's supply curve shifts

  leftward

Answer explanation

fertilizer is needed to grow rutabagas, and an increase in the price of an input shifts market supply leftward, raising the market price and reducing market quantity