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Chapter 8/The Firm and the Industry Under Perfect Competition 3

Chapter 8

THE FIRM AND THE INDUSTRY UNDER


PERFECT COMPETITION
TRUE-FALSE QUESTIONS
PERFECT COMPETITION DEFINED
1.

Perfect competition is an ideal market structure.


ANSWER T, M, R

2.

Perfectly competitive markets have absolutely no drawbacks.


ANSWER F, M, R

3.

Perfect competition forms one extreme of the market structure spectrum.


ANSWER T, E, R

4.

Perfect competition is characterized by numerous firms.


ANSWER T, E, R

5.

It is relatively easy for a firm to enter a perfectly competitive market.


ANSWER T, M, R

6.

Perfectly competitive markets feature relatively high barriers to entry.


ANSWER F, E, R

7.

Under the theory of perfect competition, firms and buyers know the availability and prices
associated with all products in the market.
ANSWER T, M, R

8.

Under perfect competition, firms are relatively ignorant of the actions of their competitors.
ANSWER F, E, R

9.

In perfect competition there are differences in the products sold by various firms.
ANSWER F, M, R

10.

In the long run, a perfectly competitive industry tends to develop differentiated products.
ANSWER F, D, R

11.

Perfectly competitive firms are known for being price makers.


ANSWER F, E, R

12.

The market for toothpaste is a good example of perfect competition.


ANSWER F, E, A

4 Chapter 8/The Firm and the Industry Under Perfect Competition


13.

Perfectly competitive markets are not the best at producing the goods that are desired by
consumers.
ANSWER F, E, R

14.

Perfectly competitive markets are not the most efficient type.


ANSWER F, E, R

THE COMPETITIVE FIRM


15.

A perfectly competitive firm is a price taker because it cannot sell its product for more
than the market price.
ANSWER T, E, R

16.

A perfectly competitive firm is a price maker.


ANSWER F, M, R

17.

A perfectly competitive firm may, under some circumstances, be able to affect the market
price.
ANSWER F, E, R

18.

A perfectly competitive firm has a horizontal demand curve because it can sell as much as
it wants at the market price.
ANSWER T, E, R

19.

The demand curve of a perfectly competitive firm is vertical.


ANSWER F, E, R

20.

In perfect competition, a firms marginal revenue equals the price of the product.
ANSWER T, D, A

21.

A perfectly competitive firm will not operate where MC = MR but at MC = AC.


ANSWER F, M, R

22.

A firm operating at MC = MR must be making a profit.


ANSWER F, E, A

23.

A perfectly competitive firm can maximize profits by producing the quantity at which MR
exceeds MC by the greatest amount.
ANSWER F, M, A

24.

In the short run, a perfectly competitive firm can make a profit, a loss, or shut down.
ANSWER T, M, R

25.

In the short run, a perfectly competitive firm can make a profit, a loss, or go out of
business.
ANSWER F, M, R

26.

Once a firms marginal revenue curve is known, the output level can be determined.
ANSWER F, M, A

Chapter 8/The Firm and the Industry Under Perfect Competition 5


27.

The short-run equilibrium output of a competitive firm is found by equating marginal cost
with price.
ANSWER T, M, R

28.

Total profit of a competitive firm can be found by multiplying profit per unit times units
sold.
ANSWER T, E, A

29.

If a firm sells its output at a price greater than AC, it will earn economic profit.
ANSWER T, E, A

30.

If a firm sells its output at a price greater than AVC, it will earn economic profit.
ANSWER F, M, A

31.

In the short run, a firm may have accounting losses and remain in operation.
ANSWER T, M, A

32.

If TR < TC, a perfectly competitive firm will always shut down.


ANSWER F, M, A

33.

As long as TVC < TR, a firm will have a positive level of output in the short run.
ANSWER T, E, A

34.

Using only marginal revenue and marginal cost, we can determine whether a firm is
incurring a profit or a loss.
ANSWER F, M, A

35.

The lowest price that a competitive firm will accept without closing its doors is found by
examining the average variable cost curve.
ANSWER T, M, A

36.

It pays the firm to produce only if total variable costs exceed total revenue.
ANSWER F, D, A

37.

In the short run, if price is below AC, maximizing profits really means minimizing total
losses.
ANSWER T, D, A

38.

The short-run supply curve for a perfectly competitive firm is that portion of the MC curve
above the AVC curve.
ANSWER T, E, R

39.

The short-run supply curve for the perfectly competitive firm is that part of the marginal
cost curve that lies above the average fixed cost curve.
ANSWER F, M, A

40.

A perfectly competitive firms short-run supply is infinite at the market price.


ANSWER F, E, R

6 Chapter 8/The Firm and the Industry Under Perfect Competition

THE COMPETITIVE INDUSTRY


41.

In the short-run, only a limited number of new firms may enter a perfectly competitive
market.
ANSWER F, M, R

42.

The short-run market demand schedule in perfect competition is positively sloped.


ANSWER F, E, R

43.

The market demand schedule in perfect competition is horizontal.


ANSWER F, E, R

44.

The entry of new firms into a perfectly competitive market shifts the demand curve
outward.
ANSWER F, M, A

45.

Zero economic profit means that the firms owners receive no compensation for their
investment.
ANSWER F, M, R

46.

The opportunity cost of a given investment is the potential earnings forfeited by tying up
money in the investment.
ANSWER T, E, A

47.

Economic profit equals gross earnings minus the firms direct costs.
ANSWER F, M, R

48.

Zero profit in the economic sense means that firms are earning a normal rate of return.
ANSWER T, M, R

49.

A firm that is earning zero economic profit should go out of business.


ANSWER F, M, R

50.

In a long-run equilibrium in a perfectly competitive market, the average firm earns positive
economic profits.
ANSWER F, E, R

51.

In a long-run equilibrium in a perfectly competitive market, firms are selling at a price


equal to marginal cost.
ANSWER T, E, R

52.

In a long-run equilibrium in a perfectly competitive market, firms are selling at a price


equal to average cost.
ANSWER T, E, R

53.

In the long run, a perfectly competitive firm maximizes profit so P = MC = AC.


ANSWER T, E, R

54.

In the long run, a perfectly competitive firm earns no accounting profits.


ANSWER F, E, A

Chapter 8/The Firm and the Industry Under Perfect Competition 7


55.

In long-run equilibrium, a firm in perfect competition has no economic profit.


ANSWER T, M, R

56.

An industry supply curve is the horizontal summation of the supply curves of all of the
individual firms.
ANSWER T, E, A

57.

In the long run, any firm may enter or leave a perfectly competitive market.
ANSWER T, E, R

58.

The number of firms in a perfectly competitive industry is not fixed in the long run.
ANSWER T, M, A

59.

For a perfectly competitive firm, the long-run supply curve is the long-run average cost
curve.
ANSWER T, M, A

PERFECT COMPETITION AND ECONOMIC EFFICIENCY


60.

In long-run equilibrium in perfect competition, every firm is producing at minimum


average cost.
ANSWER T, E, R

61.

Firms in a perfectly competitive market produce at minimum average cost in the short run
and the long run.
ANSWER F, M, A

62.

Subsidizing firms that pollute will reduce pollution in the long run.
ANSWER F, E, R

MULTIPLE-CHOICE QUESTIONS
PERFECT COMPETITION DEFINED
63.

A market
a. may be an organized exchange.
b. refers to a set of sellers and buyers whose actions affect a commoditys price.
c. is that area in which buyers and sellers compete to effect a product price.
M,R d. All of the above are correct.
64.

To determine whether a market is perfectly competitive, economists examine the


a. number of firms in the market.
b. similarities among the products of the different firms in the market.
c. ease of entry and exit by firms in the market.
E,R d. All of the above are correct.

8 Chapter 8/The Firm and the Industry Under Perfect Competition


65.

The strength of the competition faced by a company can profoundly affect its
a. pricing.
b. output decisions.
c. input decisions.
M,A d. All of the above are correct.
66.

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


a. Firms and consumers all have perfect information about the good and market.
b. Sellers can enter the market easily.
c. All goods sold are identical.
E,R d. All consumers have identical individual demand curves.
67.

A perfectly competitive firm is a price


a. giver.
E,R b. taker.
c. maker.
d. leader.
68.

Which of the following is a characteristic of a perfectly competitive market?


a. a few large firms
b. firms producing specialized products in order to attract consumers
c. each individual firm having some control over the market price
E,R d. a large number of small firms
69. One of the following is not a characteristic of perfect competition. Which is it?
M,R a. Firms advertise to increase their market share.
b. Profits are low.
c. Consumers pay little attention to brand names.
d. Firms pay no attention to their competitors output levels.
70. Firms in perfect competition are often described as price
E,R a. takers.
b. makers.
c. setters.
d. leaders.
71. Which of the following most resembles a perfectly competitive market?
M,I a. the stock market
b. the publishing industry
c. the steel industry
d. the new car market

Chapter 8/The Firm and the Industry Under Perfect Competition 9


72.
E,I

Perfect competition is the term used to describe


a. an industry in which all businessmen are honest and accommodating.
b. an industry in which numerous firms produce identical products.
c. an industry untouched by government regulation.
d. the kind of industry any American would support.

73.

Economists study perfect competition


a. because many markets are perfectly competitive.
b. for its descriptive realism.
M,R c. to establish a benchmark by which to measure the performance of the economy.
d. All of the above are correct.
74.

E,I

Which of the following is closest to the economists definition of perfect competition?


a. the airline industry
b. the soft drink industry
c. the fishing industry
d. the long-distance telephone service

75.

The result that perfectly competitive firms produce at the lowest per-unit cost is derived
from the assumptions of
a. homogeneous products.
b. few sellers.
c. firms facing horizontal demand curves.
D,I d. free entry and exit.

THE COMPETITIVE FIRM


76.

In a market with perfectly competitive firms, the market demand curve is usually ______
and the demand curve facing each individual firm ______.
a. upward sloping; horizontal
M,R b. downward sloping; horizontal
c. horizontal; downward sloping
d. downward sloping; downward sloping
77.

E,I
78.

A firm facing a horizontal demand curve


a. cannot affect the price it receives for its output.
b. always produces at an output at which P = MR.
c. faces perfectly elastic demand for its product.
d. All of the above are correct.

For a perfectly competitive firm, marginal revenue equals average revenue because the
a. firms supply curve is horizontal.
b. industrys demand curve is horizontal
D,A c. firms demand curve is horizontal.
d. industrys supply curve is horizontal.

10 Chapter 8/The Firm and the Industry Under Perfect Competition


79.

In a perfectly competitive industry, influence over price is exerted by


a. individual sellers.
b. individual buyers.
c. the largest firms.
M,R d. the forces of supply and demand.
80. The competitive firm has no influence over price because
M,A a. its output is so insignificant relative to the market as a whole.
b. anti-trust laws constrain perfectly competitive firms.
c. consumers establish the prices of products.
d. it doesnt know its demand curve.
81. At a perfectly competitive firms short-run equilibrium level of output,
M,R a. P = MR = MC.
b. P = MR, but MR does not equal MC.
c. P = MC, but MR does not equal MC.
d. MR = MC and P < MR.
82. In short-run equilibrium, a perfectly competitive firm
E,R a. may earn a profit or a loss.
b. always earns a profit.
c. never earns a profit.
d. earns a profit only if the firm has no fixed cost.
83.

A firm in short-run equilibrium always earns positive profits if


a. SRAC > P > SRAVC.
M,I b. SRAR > SRAC.
c. MR = MC.
d. SRAC > MC.

Chapter 8/The Firm and the Industry Under Perfect Competition 11

FIGURE 8-1

84.

If the profit-maximizing firm depicted in Figure 8-1 is perfectly competitive, how much
output should it produce?
a. A
b. B
E,A c. C
d. D
85.

A firm earns a profit of exactly zero at its optimal output level only if
a. P = MR.
b. P = MC.
M,A c. P = AC.
d. P = SR AVC.
TABLE 8-1

Q (in units) AFC (in dollars)


0
C
2
2.5
4
1.25
6
0.83
8
0.63
10
0.5

AVC (in dollars)


C
18
14
18
30
50

MC (in dollars)
C
10
14
42
94
170

12 Chapter 8/The Firm and the Industry Under Perfect Competition


86.

In Table 8-1 are the short-run cost schedules of a perfectly competitive firm. If the market
price of output is $50, the firm will produce ______ units and earn a profit of ______.
D,I a. 6; $187.02
b. 6; $48
c. 8; $154.96
d. 8; $245.04

FIGURE 8-2

87.

Figure 8-2 shows demand and short-run cost curves for a perfectly competitive firm. At its
profit-maximizing level of output, the firms short-run TC is represented by area
M,I a. ADFO.
b. BGHC.
c. BGIO.
d. ADGIO.
88.

Figure 8-2 shows demand and short-run cost curves for a perfectly competitive firm. At its
profit-maximizing output, the firms total ______ is represented by area ______.
a. loss; GBHC
b. profit; ADGHC
D,I c. loss; ADEC
d. profit; EGH

Chapter 8/The Firm and the Industry Under Perfect Competition 13


89.

Figure 8-2 shows demand and short-run cost curves for a perfectly competitive firm. In the
short run, this firm would
a. earn positive economic profits.
M,I b. earn economic losses.
c. go out of business.
d. Cannot be determined with the information given.
TABLE 8-2
A perfectly competitive producer has the following short-run average cost curve and marginal
cost curve:
SR AC = 2Q + 3
MC = 4Q + 3
where costs are measured in dollars and Q represents the firms output in units.
90.

If the market price of wangdoodles is $15 each, the profit-maximizing producer whose
short-run cost curves are given in Table 9-2 should produce ______ wangdoodles.
a. 0
D,I b. 3
c. 6
d. 15
91. The firm whose short-run cost curves are given in Table 8-2 has a long-run fixed cost of
M,A a. $0.
b. $2.
c. $3.
d. $4.
92.

In the short run, perfectly competitive firms can


a. make an economic profit.
b. take a loss.
c. break even.
E,R d. All of the above are correct.

14 Chapter 8/The Firm and the Industry Under Perfect Competition

FIGURE 8-3

93.

In Figure 8-3, the profit maximizing firm will operate at a level of


a. OJ.
b. OG.
E,A c. OI.
d. OH.
94.

In Figure 8-3, the perfectly competitive firm is realizing a


a. loss equal to ABCE.
b. profit equal to ABCE.
M,A c. profit equal to ABDF.
d. loss equal to ABDF.
95.

In Figure 8-3, the firms minimum cost per unit occurs at an output of
a. OJ.
E,A b. OG.
c. OI.
d. OH.
96.

In perfect competition, marginal revenue always equals


a. total revenue.
b. price.
E,R c. average cost.
d. marginal fixed cost.

Chapter 8/The Firm and the Industry Under Perfect Competition 15


97.

A perfectly competitive firm should continue to expand output until


a. total revenue exceeds total costs.
b. total revenue exceeds variable costs.
E,R c. marginal revenue equals marginal costs.
d. average revenue equals variable costs.
98.

A competitive firm will always maximize profits by producing where


a. per-unit costs are lowest.
b. total costs and total revenue are equal.
E,R c. P = MC.
d. P = AC.

FIGURE 8-4

99.

Figure 8-4 shows the industrys supply and demand curves in panel (1) and the cost curves
of a firm in the industry in panel (2). At S1, the firm is
a. shut down.
b. incurring losses.
c. earning zero economic profits.
M,A d. earning economic profit greater than zero.
100. Figure 8-4 shows the industrys supply and demand curves in panel (1) and the cost curves
of a firm in the industry in panel (2). At S2, the firm is
a. shut down.
b. incurring losses.
M,A c. earning zero economic profits.
d. earning economic profit greater than zero.

16 Chapter 8/The Firm and the Industry Under Perfect Competition


101. Figure 8-4 shows the industrys supply and demand curves in panel (1) and the cost curves
of a firm in the industry in panel (2). At S3, the firm is
M,A a. shut down.
b. incurring losses.
c. earning zero economic profits.
d. earning economic profit greater than zero.
102. The perfectly competitive firms short-run shutdown rule is to shut down immediately if
a. TR < TC.
b. TR < SRFC.
M,A c. TR < SRVC.
d. TR < MC > Q.
103. At a firms profit-maximizing level of output, its price is $200 and its short-run average
total cost is $225. The firm
a. has a profit of $25 per unit of output.
b. should shut down if its short-run average fixed cost is less than $25.
c. has a loss of $100 per unit of output.
D,I d. should shut down if its short-run average variable cost exceeds $25.
104. A firm can stay in business while taking a loss in the short run as long as it covers its
a. fixed costs.
M,R b. variable costs.
c. fixed and variable costs.
d. A firm can never stay in business when it experiences losses.
105. A firm will shut down if
a. TR TC > TFC.
b. TR + TC > TFC.
D,A c. TC TR > TFC.
d. TFC + TVC > TR.
106. A firm will shut down in the short run if
M,A a. P < AVC.
b. P > AVC.
c. AVC > AFC.
d. TR > TC.
107. If a firm shuts down in the short run, its losses are equal to
a. TC TR.
M,A b. TFC.
c. TVC.
d. MC.

Chapter 8/The Firm and the Industry Under Perfect Competition 17


108. Sunk costs are created in the short run by
a. contract for labor services.
b. lease agreement on real estate.
c. purchasing machinery.
M,I d. All of the above are correct.
109. If a firm shuts down, its
a. sunk costs remain unchanged.
b. revenue will fall to zero.
c. short-run variable costs will fall to zero.
M,I d. All of the above are correct.
110. The short-run supply curve of a perfectly competitive firm
a. goes through the lowest point on its short-run average total cost curve but not on its
short-run average variable cost curve.
b. goes through the lowest point on its short-run average variable cost curve but not on
its short-run average total cost curve.
M,A c. goes through the lowest point on both its short-run average variable cost and its shortrun average total cost curves.
d. goes through the lowest point on its short-run average total cost curve and may or may
not go through the lowest point on its short-run average variable cost curve.
111. In perfect competition, an increase in fixed costs will eventually cause all except
a. reduction in industry output.
D,A b. reduction in a firms output.
c. reduction in the number of firms.
d. decrease in industry supply.
112. The short-run supply curve of the competitive firm is the firms
a. MC curve.
b. AVC curve.
M,R c. MC curve above the minimum point on the AVC curve.
d. MC curve above the minimum point on the AFC curve.
113. If the price falls below minimum SRAVC, the quantity supplied by the firm will be
a. the quantity at minimum MC.
M,A b. zero.
c. the quantity at the point where MC intersects AC.
d. the quantity at minimum AC.
114. The quantity which a firm will supply in the short run
a. can be read from its average cost curve.
b. can be read from its average variable cost curve.
M,A c. can be read from the firms marginal cost curve above average variable cost.
d. is always zero above minimum average variable cost.

18 Chapter 8/The Firm and the Industry Under Perfect Competition

FIGURE 8-5

115. In Figure 8-5, points which lie on the firms short-run supply curve are
a. A, B, C.
M,A b. C, D, H.
c. F, E, G.
d. A, C, H.

THE COMPETITIVE INDUSTRY


116. The supply curve for a competitive industry is obtained by
a. making an empirical study of historical data.
b. vertically summing the supply curves of firms in the industry.
c. horizontally summing the average cost curves of firms in the industry.
M,R d. horizontally summing the supply curves of firms in the industry.
117. The short run for the industry is defined as a period
a. too brief for new firms to enter the industry.
b. too brief for old firms to leave the industry.
c. in which the number of firms in the industry is fixed.
E,I d. All of the above are correct.
118. The long run for the industry is defined as a period of time long enough for
a. any new firm that desires to enter the industry.
b. any old firm that desires to leave the industry.
c. all aspects of production to vary, including the number of firms in the industry.
E,I d. All of the above are correct.

Chapter 8/The Firm and the Industry Under Perfect Competition 19


119. When a firm leaves a perfectly competitive industry,
D,I a. the individual demand curves facing remaining firms shift up in the long run.
b. short-run industry equilibrium is re-established at a new point along the original
short-run industry supply curve.
c. the short-run industry supply curve shifts to the right.
d. at the new long-run equilibrium, the remaining firms in the industry will each receive
a higher profit.
120. The short-run supply curve of the competitive industry is found by summing the
a. AC curves of the individual firms in the industry.
b. AVC curves of the individual firms in the industry.
M,I c. MC curves above AVC of the individual firms in the industry.
d. There is no short-run supply curve in a competitive industry.
121. A firm in a perfectly competitive industry
a. is unaffected by the entrance of new firms into the industry, since entering firms affect
only the prices they themselves receive.
b. always produces more output in the long run than in the short run.
M,R c. may choose a different input mix in the long run than in the short run.
d. earns economic profit in the long run but not in the short run.

FIGURE 8-6

20 Chapter 8/The Firm and the Industry Under Perfect Competition


122. Figure 8-6 shows supply and demand conditions in a perfectly competitive industry and
for a firm in that industry. Assume the industry initially has supply curve S1 and demand
curve D1. If demand shifts to D2, then in the short run price will
E,I a. rise to A.
b. rise to some level between A and B.
c. remain at B.
d. fall to C.
123. Figure 8-6 shows supply and demand conditions in a perfectly competitive industry and
for a firm in that industry. At a price of $C, the firm would
a. earn zero economic profit.
M,A b. earn negative economic profit.
c. have a zero opportunity cost of capital.
d. have a negative opportunity cost of capital.
124. Given an industry demand curve, QD = 20 2P, and an industry supply curve, QS = 2 + P,
industry equilibrium price in the short run will be
a. $20.
b. $10.
D,A c. $6.
d. $3.
125. Given an industry demand curve, QD = 20 2P, and an industry supply curve, QS = 2 + P,
industry equilibrium quantity in the short run will be
a. 18.
b. 12.
c. 10.
D,A d. 8.
126. We expect the demand curve in the perfectly competitive industry to be
E,R a. negatively sloped.
b. vertical.
c. horizontal.
d. perfectly elastic.
127. When a firm enters the steel industry, the short-run equilibrium price of steel
E,A a. always falls.
b. falls only if existing firms gang up on the entrant.
c. falls only if existing firms are earning no economic profit.
d. falls only if the new firm is more efficient than existing firms.
128. Firms entering a competitive industry will cause the price of the product to
E,A a. fall.
b. rise.
c. remain constant.
d. become more responsive to consumer demand.

Chapter 8/The Firm and the Industry Under Perfect Competition 21


129. Perfectly competitive firms ______ earn zero economic profit in long-run equilibrium
because ______.
a. always; firms in perfectly competitive industries always maximize output and so flood
the market until the equilibrium price of output is driven to zero
b. sometimes; the demand curve for an individual perfectly competitive firm may or may
not cross the companys long-run average total cost curve at its lowest point
M,I c. always; firms enter whenever their economic profit is positive and exit whenever its
negative, so in long-run equilibrium economic profit must always be zero
d. never; no firm would be willing to produce if it received zero economic profit
130. If the opportunity cost of capital is below the rate of return to capital in the perfectly
competitive beauty salon industry,
D,I a. resources will flow into the industry.
b. beauty salon owners must be earning negative economic profit.
c. the beauty salon industry cannot be in long-run equilibrium.
d. beauty salon owners must be earning negative marginal revenue at their current levels
of output.
131. The difference between zero profit and zero economic profit is that
M,R a. economists include opportunity cost in zero economic profit, while accountants do not
include opportunity cost in zero profit.
b. economists do not include opportunity cost in zero economic profit, while accountants
do include opportunity cost in zero profit.
c. economists include opportunity cost in zero profit, while accountants do not include
opportunity cost in zero economic profit.
d. economists do not include opportunity cost in zero profit, while accountants do
include opportunity cost in zero economic profit.
132. Helga owns Viking, Inc., started with her $100,000 inheritance. Helgas accountant informs
her that her firm earned a profit of $100,000 last year, and that if she chooses to invest the
money she can expect a 10% return. If Helga did not run Viking, she would not work.
What were Helgas economic profits last year?
a. Zero
b. $100,000
c. $90,000
D,A d. $95,000
133. Richard Bland quit his job as an accounting professor to start his own restaurant. He gave
up a salary of $50,000 per year and withdrew $100,000 in bank CDs earning 5 percent to
buy a building and equipment. In the restaurants first year it had direct expenses of
$75,000 and revenues of $150,000. The restaurants economic profit was
a. $15,000.
D,A b. $20,000.
c. $75,000.
d. not possible to determine from the information given.

22 Chapter 8/The Firm and the Industry Under Perfect Competition


134. A perfectly competitive firm would be willing to remain in the industry in the long run at
zero economic profit because
a. it would find it too difficult to exit from the industry in the long run.
b. accounting profit would be negative.
E,A c. revenue is equal to all costs, including the opportunity cost of capital and labor.
d. its sunk costs would prevent it from leaving the industry.
135. Zero economic profits for a perfectly competitive firm in the long run means
a. the firm must exit the industry.
E,A b. the firm is in equilibrium.
c. the firm will shut down until the market improves.
d. average revenue is insufficient to cover long-run average cost.
136. Long-run average cost of the perfectly competitive firm includes the
a. cost of raw materials per unit of output.
b. opportunity cost of labor per unit of output.
c. opportunity cost of capital per unit of output.
M,I d. All of the above are correct.
137. Which of the following statements is not true in a perfectly competitive industry in longrun equilibrium?
D,I a. A profit-maximizing firm may produce any output level at which P < LRAC.
b. Every firm produces at an output level at which MC = LRAC.
c. There is no entry or exit from the industry.
d. No firm earns an economic profit.
138. The perfectly competitive widget industry is in long-run equilibrium. A profit-maximizing
manufacturer receives total revenue of $55,000. He uses his labor, $15,000 worth of wire,
and $15,000 worth of steel to make the widgets. The manufacturer
a. is earning an economic profit of $25,000.
b. must have an opportunity cost of labor of less than $25,000.
D,A c. must have an opportunity cost of labor of exactly $25,000.
d. must have an opportunity cost of labor of more than $25,000.
139. The entry of firms into a competitive industry causes the supply curve to
a. increase its slope.
b. decrease its slope.
E,A c. move farther toward the right.
d. move toward the left.
140. An increase in demand will cause an increase in industry output in the long run because
M,I a. new firms enter the industry.
b. new firms enter the industry and all firms increase their output.
c. all firms decrease their output but more new firms enter.
d. no firms enter but the existing firms increase their output.

Chapter 8/The Firm and the Industry Under Perfect Competition 23


141. The market for a perfectly competitive industry clears at a price of $3, and the minimum
average cost for all firms is $2.50. In the long run, we would expect an increase in
a. each firms output.
M,A b. the number of firms.
c. each firms profit.
d. each firms average cost.
142. The long-run supply curve of an industry equals the industrys
a. long-run marginal cost curve.
b. the horizontal sum of all firms supply curves at any point in time.
D,R c. long-run average cost curve.
d. long-run total variable cost curve.
143. Regardless of quantity in long-run equilibrium, the industry price cannot exceed the
M,R a. long-run average cost of supplying that quantity.
b. total variable cost of supplying that quantity.
c. long-run total cost of supplying that quantity.
d. minimum long-run marginal cost of supplying that quantity.
144. The long-run industry supply curve in perfect competition is derived from the
a. short-run industry supply curve which shifts as new firms enter the industry.
b. short-run industry supply curve which shifts as old firms exit the industry.
c. freedom of firms from sunk costs so that new cost curves become long-run curves.
M,I d. All answers above are important in deriving the long-run industry supply curve.
145. In a perfectly competitive industry, if price exceeds LRAC, we may be sure
a. equilibrium has not been reached.
b. new firms will continue to enter the industry.
c. the long-run industry supply curve will shift to the right.
E,I d. All of the above are correct.

24 Chapter 8/The Firm and the Industry Under Perfect Competition


146. The process of adjustment to a new long-run equilibrium in a perfectly competitive
industry is complete when
a. no firms want to enter or exit the industry.
b. every firm has adjusted its production process to make the most efficient use of its
resources.
c. investors in the industry receive the standard economy-wide rate of return on their
investments.
M,I d. All of the above are correct.

FIGURE 8-7

147. In Figure 8-7, the price at long-run equilibrium is


a. $5.
b. $10.
M,A c. $20.
d. $35.
148. At its long-run equilibrium level of output, the demand curve facing an individual
perfectly competitive firm is tangent to its
a. total economic profit curve.
M,A b. long-run average cost curve.
c. marginal cost curve.
d. marginal revenue curve.

Chapter 8/The Firm and the Industry Under Perfect Competition 25


149. Firms will continue to enter a competitive industry until
a. the supply curve is vertical.
b. the supply curve is meaningless.
M,R c. any excess returns have been competed away.
d. all resources are fully employed.
150. A perfectly competitive industry in long-run equilibrium is described as efficient because
firms
M,R a. produce at the low point on their average cost curve.
b. produce where marginal cost yields a profit.
c. earn no more than the cost of capital.
d. are not profitable.
151. If you must determine the long-run equilibrium output of a competitive firm and you are
permitted to see only one curve, which of the following curves is most helpful?
a. demand
b. marginal cost
D,A c. average cost
d. average fixed cost

FIGURE 8-8

152. In Figure 8-8, through which point must a horizontal demand curve pass to yield a longrun equilibrium?
M,A a. A
b. B
c. C
d. All of the above is correct.

26 Chapter 8/The Firm and the Industry Under Perfect Competition


153. In Figure 8-8, output at which point represents short-run but not long-run equilibrium?
a. A
M,I b. B
c. C
d. All of the above is correct.

FIGURE 8-9

154. Figure 8-9 displays the cost curves of a perfectly competitive firm. Profits at a price of $10
would be approximately
M,I a. $1 per unit.
b. $3 per unit.
c. $5 per unit.
d. $10 per unit.
155. For the perfectly competitive firm in Figure 8-9, what is the long-run price and quantity?
a. P = 4, Q = 150
M,A b. P = 9, Q = 200
c. P = 10, Q = 200
d. P = 5, Q = 150
156. In the long run, the perfectly competitive firm in Figure 8-9 will leave the industry if the
price falls below
a. $10.
M,A b. $9.
c. $5.
d. $2.

Chapter 8/The Firm and the Industry Under Perfect Competition 27


157. In the short run, the firm in Figure 8-9 will shut down if the price falls below
a. $8.
b. $6.
M,A c. $5.
d. $1.
158. The entry of new firms into an industry will very likely
a. shift the industry supply curve to the right.
b. cause the market price to fall.
c. reduce the profits of existing firms in the industry.
E,I d. All of the above are correct.
159. In long-run equilibrium under perfect competition,
a. the firm and the industry will have the same cost curves.
b. only a very few firms will be earning economic profits.
M,A c. the demand curves facing individual firms will fall to the level of minimum AC.
d. individual firms will tend to increase their outputs.
160. Which of the following statements concerning equilibrium in the long run is not true?
M,R a. Most firms earn economic profits in the long run.
b. The firm can vary its plant size in the long run.
c. Economic profits are eliminated as new firms enter the industry in the long run.
d. For firms in long-run equilibrium, P = MC = AC.

PERFECT COMPETITION AND ECONOMIC EFFICIENCY


161. In long-run equilibrium, the perfectly competitive firm produces
a. where P = MC = AC.
b. at the lowest point on its long-run average cost curve.
c. where its long-run average cost curve is tangent to its horizontal demand curve.
M,I d. All of the above are correct.
162. The most efficient market structure in the long run is
E,R a. perfect competition.
b. monopolistic competition.
c. oligopoly.
d. monopoly.

28 Chapter 8/The Firm and the Industry Under Perfect Competition


163. If government forced a firm to charge a price equal to marginal cost in a situation where
there are scale economies,
a. new firms would enter the industry.
D,A b. the firm would be forced to go bankrupt.
c. positive economic profit would grow even larger.
d. marginal cost would exceed average cost.

WHICH IS BETTER TO CUT POLLUTIONTHE CARROT OR THE STICK?


164. A tax on polluting firms
M,A a. would shift the LRAC curve upward.
b. would shift the LRAC curve downward.
c. would have the same impact on the firm as a subsidy.
d. tends to have the perverse effect of increasing pollution.
165. If the objective of economic policy is to decrease the amount of pollution by an industry in
the long run, the
a. most effective policy action would be a subsidy to firms for the reduction of emissions.
M,A b. most effective policy action would be a tax on polluting firms.
c. appropriate course of action for government is to do nothing.
d. appropriate course of action for government is to increase R&D outlays to develop
technology to remove the emissions from the environment.
166. A subsidy to firms intended to reduce pollution in an industry would
a. shift the LRAC curve upward.
b. have the same impact on the firm as a tax.
c. likely drive some existing firms from the industry.
M,A d. likely have the paradoxical effect of increasing pollution in the industry in the long
run.

ESSAY QUESTIONS
167. Give a complete but concise definition of the following terms.
a. perfect competition
b. perfectly competitive firms demand curve
c. shutdown point
d. long-run equilibrium in perfect competition
ANSWER E, R

Chapter 8/The Firm and the Industry Under Perfect Competition 29


a.

b.
c.
d.

Perfect competition is a market structure in which there are many small firms each
selling a homogeneous product, with freedom of entry and exit and complete
information.
The perfectly competitive firms demand curve is horizontal, which means it can sell as
much as it wishes at the prevailing market price.
The shut-down point for the firm in the short run is the output point where average
revenue is less than average variable cost.
Long-run equilibrium for the perfectly competitive firm is an output level such that P = MC
= AC and economic profit is zero.

168. Define the following terms and explain their importance to the study of economics.
a. marginal cost
b. marginal revenue
c. short-run equilibrium
d. supply curve of the firm
e. economic profit
ANSWER E, R
a. Marginal cost is the cost to the firm of producing and selling an additional unit of the
good.
b. Marginal revenue is the amount of extra revenue the firm receives for producing and
selling one more unit of a good.
c. Short-run equilibrium occurs in the time period in which some commitments cannot
be changed. The number of firms in the industry cannot be changed. The competitive
firm will equate P to MC > AVC to choose profit-maximizing (or loss-minimizing)
price and output. If price is below the minimum of AVC, the firm will minimize losses
by shutting down.
d. The supply curve for the competitive firm is MC > AVC. If price is below the minimum
of AVC, the firm will minimize losses by shutting down.
e. Economic profit equals net earnings, in the accountants sense, minus the opportunity
cost of capital and of any other inputs supplied by the firms owners. It is assumed
that firms seek to maximize economic profits. In a competitive industry in the long
run, economic profits are zero.
169. What are the assumptions of the model of perfect competition? Explain why each is
important for short-run and long-run equilibrium.
ANSWER M, R
There are four assumptions:
1.

Numerous small firms and customers. Each buyer and each seller is so small that each has
only a negligible portion of the whole market. Therefore, none is able to control price or
output of the industry.

30 Chapter 8/The Firm and the Industry Under Perfect Competition


2.

Homogeneity of product. Or, no product differentiation, including brand names or


trademarks. Because the product offered by any seller is identical to that offered by any
other seller, consumers do not care from which firm they buy. Therefore, no producer is
able to charge a premium price.

3.

Freedom of entry and exit. New firms can enter the market with no impediments, and firms
are able to leave the industry with no problems. If there are economic profits in the
industry, we expect firms to enter, increasing industry supply and driving price lower.

4.

Perfect information. Each firm and each customer is well informed about the available
products and prices. They are able to compare prices and seek the lowest price.
The result is that the firm has no control over price and is a price taker. Market demand
and market supply determine the price. The firm will maximize short-run profits by
equating MR = P = MC > AVC and by producing at the quantity at which this equilibrium
occurs. If P < minimum AVC, the firm will minimize losses by shutting down. In the long
run, firms will enter or leave the industry based on profit opportunities, and there will be
no economic profits or losses. If the price should rise or fall enough to cause economic
profits or losses, there will be entry or exit of firms until economic profits of all firms in the
industry are zero.

170. Of the following industries, which are perfectly competitive? Of those which are not, why
do they not fit the model?
a. local banking
b. gasoline stations
c. college-level educational institutions
d. local radio and television
e. local farmers market
ANSWER M, I
a. Local banking is not (generally) perfectly competitive. In small towns, there are at most
only a few banks. In larger cities, there are more banks from which to choose. Further,
banks compete on image, size, service, etc., and not always on price. Location and
hours of service may vary.
b. Gasoline stations are close to perfectly competitive, but many customers will shop on
the basis of brand names. If so, the industry is monopolistically competitive.
c. Colleges are differentiated. They are generally distinguished by size, quality of
instruction, etc. This is an example of monopolistic competition.
d. Local radio and television can be oligopolistic in many smaller markets and close to
monopolistic competition in large markets. Differentiation is common, with different
formats (talk, classical, rock, etc.).
e. Local farmers markets are probably the closest to perfect competition on the list. Each
buyer and seller is small relative to the market; produce is not usually differentiated;
and all are able to shop quickly and easily to compare price and output quality.
171. Why study perfect competition, if it rarely exists?
ANSWER E, R

Chapter 8/The Firm and the Industry Under Perfect Competition 31


Perfect competition is the circumstance where the market performs best, demonstrating
Adam Smiths invisible hand in action. Each firm, acting in its own self-interestthe
pursuit of maximum profitends up acting in societys best interest; products are
produced and sold at minimum average cost in the long run. Also, even if the conditions of
the model are not fulfilled, firms may still act as if the assumptions held. So the models
predictive power may extend beyond the cases of agricultural and stock markets.
172. Draw a graph illustrating the relationship between the demand curve of the perfectly
competitive firm and the perfectly competitive industry. Label all curves and axes correctly.
ANSWER M, I
The diagram of the firm and industry should look like Figure 8-1 in the text. The firms
demand curve should be horizontal at the industry equilibrium price.
173. Why doesnt a competitive firm reduce its price below the industry price to increase sales?
ANSWER E, A
A competitive firm can sell all it wishes at the going industry price; that is the meaning of a
horizontal demand curve. There would be no point to charging less if one can sell all one
wants at a higher price. Furthermore, such a policy would result in losses in the long run,
where industry price results in zero economic profits and any lower price would result in
losses.
174. Why doesnt a perfectly competitive firm charge a price slightly higher than the industry
price in order to earn extra profit?
ANSWER E, A
A perfectly competitive firm is producing a product that is identical to the output of each
of its competitors. Additionally, it is only one firm of many in the market. Thus, no buyer
would pay a price above the industry rate in order to buy from one particular firm; instead,
the consumer would simply buy from one of the many other firms.
175. What makes the demand curve of the perfectly competitive firm uniquely different from
that of firms in other kinds of market structures?
ANSWER E, R
The perfectly competitive firms demand curve is horizontal, which means it can sell as
much as it wants at the market price. This is possible because each firm under perfect
competition is so insignificant relative to the market as a whole that it has no influence over
price; it is a price taker.
176. What is the difference between the short run and the long run as economists define the
two?
ANSWER E, R
The short run is a period of time within which at least one resource is fixed. It could be a
commitment for a rental lease, for example. The short run is also a period too short for new
firms to enter the industry or for firms currently in the industry to exit. For the long-run
period, all resources may vary; hence, all costs are variable costs. New firms may enter the
industry and old firms may exit.

32 Chapter 8/The Firm and the Industry Under Perfect Competition


177. Draw a graph illustrating a competitive firm in short-run equilibrium that is earning an
economic profit. Be sure to label all curves and axes correctly.
ANSWER D, I
The diagram should look like Figure 8-2 in the text. Note that price must be higher than
the minimum of average cost.
178. If a firm has short-run losses, will it stay open? Under what conditions will a firm close in
the short run? Explain.
ANSWER D, A
The firm suffers losses if P < AC so that revenue does not cover costs. The firm will stay
open if P > minimum of AVC. If the firm shuts down, revenue falls to zero but fixed costs
continue as obligations of the firm. Therefore, if P > minimum of AVC, the firm can cover
its variable (avoidable) obligations and a portion of fixed (unavoidable) obligations. Such a
decision cuts losses, so that it is more profitable to produce than to close. However, if P <
minimum of AVC, the firm should close. Revenue is insufficient to cover variable
(avoidable) costs, much less cover some portion of fixed (unavoidable) costs. Loss
minimization in this case requires closing down.
179. Explain the reasoning behind the shutdown rules. When is it appropriate to operate with a
loss?
ANSWER M, I
1. The firm will make a profit if total revenue (TR) exceeds total cost (TC). In that case, it
should not plan to shut down either in the short run or in the long run.
2. The firm should continue to operate in the short run if TR exceeds short-run variable
cost (TVC). It should plan to close in the long run if TR is less than TC.
The first rule requires no explanation. The second rule relies on the distinction between
fixed and variable costs. The firm can avoid variable costs in the short run by shutting
down. However, it is unable to avoid fixed costs by shutting down. If a firm shuts down, its
losses will equal the amount of its fixed costs. If revenue exceeds total variable cost (or,
equivalently, if price exceeds the minimum of average variable cost), the firm should
operate, pay all variable costs and some portion of fixed costs, to minimize losses.
180. If there are no profits in competitive equilibrium, why do firms produce? How can they
stay in business?
ANSWER E, I
The no profits conclusion of competition refers to economic profitsthere is no excess
rate of return to the typical firm. However, each firm is able to earn sufficient accounting
profits to cover the opportunity cost of invested factors and to continue operating. The
source of the confusion is failing to distinguish between accounting and economic profits.
181. A firm sells in a competitive market in which price is $10. Its marginal cost is 2 + .5Q.
Determine the profit-maximizing level of output.
ANSWER M, A
The solution requires equating P = MC to determine Q:

Chapter 8/The Firm and the Industry Under Perfect Competition 33


P = 10 = MC = 2 + .5Q
10 = 2 + .5Q
8 = .5Q
Q = 16
182. A firm sells in a competitive market in which price is $12. Its marginal cost is 6 + .25Q.
Determine the profit-maximizing level of output.
ANSWER M, A
The solution requires equating P = MC to determine Q:
P = 12 = MC = 6 + .25Q
12 = 6 + .25Q
6 = .25Q
Q = 24
183. Describe the process that would occur in the long run in a competitive industry if there
were economic profits. Illustrate this with a diagram.
ANSWER M, I
The diagram should look like Figure 8-7 in the text. If there are economic profits, firms will
enter the industry. The industry supply will increase and the price will fall. As the price
falls, the profits of each firm will fall. The (representative) firm will therefore cut output,
moving downward on its marginal cost curve. The process of entry will end when each
firm is at the bottom of average cost so that there are no economic profits.
184. Draw a graph showing the typical competitive firm losing money but continuing to
operate. Explain why the firm continues to operate rather than shut down.
ANSWER M, I

34 Chapter 8/The Firm and the Industry Under Perfect Competition


Figure 8-10 shows price (= MR) above minimum AVC but below minimum AC. The firm is
losing money but less money than if it shuts down. Since price exceeds AVC, it is covering
all its variable costs and has funds left over, which can cover a portion of fixed cost. If the
firm shuts down, it loses all its fixed cost.

FIGURE 8-10

Chapter 8/The Firm and the Industry Under Perfect Competition 35


185. Graphically show a firm earning a profit; shade the appropriate profit rectangle. Explain
how the profit formula represented by the rectangle is analogous to TR TC.
ANSWER E, A
Figure 8-11 shows price (= MR) above minimum AC. The firm operates at the quantity Qc
where P = MC. The shaded rectangle is (Pc ACc)Qc. This is simply a restatement of TR
TC, since TR = P Q and TC = AC Q.

FIGURE 8-11

36 Chapter 8/The Firm and the Industry Under Perfect Competition


186. A firms minimum AC is $10, its minimum AVC $7. Show this firms short-run supply
curve, explaining how you obtained it.
ANSWER M, I
Draw a U-shaped AC and AVC, with Q at minimum AVC at a smaller level than for AC
(Figure 8-12). MC passes through each of these minimum points. The firms short-run
supply is MC above minimum AVC. Below minimum AVC, the firm produces zero. Only
when P exceeds minimum AVC will the firm find it worthwhile to operate; below
minimum AVC the firm is better off shutting down and losing its fixed cost.

FIGURE 8-12

Chapter 8/The Firm and the Industry Under Perfect Competition 37


187. If the typical firms minimum average variable cost is $10 at an output of 50 units, if
marginal cost is $20 at 70 units, and there are 1,000 firms in the industry, sketch supply
curves for the typical firm and for the industry as a whole.
ANSWER M, I
For the firm, plot two supply points corresponding to P = $10 and Q = 50, P = $20 and Q =
70 (Figure 8-13). For the industry, multiply the Qs by 1,000, so that industry Q = 50,000 at P
= $50 and industry Q = 70,000 at P = $20.

FIGURE 8-13

188. There are currently 1,000 firms in a competitive industry. Minimum long-run average cost
is $80 and price $100. Explain what will happen to price, profit, and the number of firms in
this industry over time.
ANSWER E, I
Price exceeds minimum long-run average cost, so that firms are earning an economic
profit. This will induce additional entry over time. As supply increases (rightward shift),
price will fall to minimum long-run average cost of $80. Economic profit will drop to zero.
189. How does a firm that is losing money in the short run decide whether to shut down or
continue to produce to minimize its losses?
ANSWER M, A
The firm should continue to produce in the short run if TR exceeds TVC; if TR falls below
TVC, the firm should shut down.

38 Chapter 8/The Firm and the Industry Under Perfect Competition


190. Sally Rand owns a ceiling fan company. She sells 1,000 ceiling fans at $50 each. Each fan
costs her $20. She uses her own money to buy the fans; she withdraws the money from her
savings account where it earns 5 percent interest. Before going into the ceiling fan business,
she worked as a fan-dancer at $25,000 a year. Should Sally remain in business?
ANSWER M, A
If her economic profit is at least zero, Sally should stay in business. Her TR = $50,000 and
her total accounting cost is $20,000, for an accounting profit of $30,000. She forgoes interest
on savings of $20,000 (.05) = $1,000 as well as forgone earnings of $25,000. This leaves
$4,000 in economic profit, so she should stay in business.
191. Explain how the short-run supply curve of the competitive firm is derived.
ANSWER M, A
Since the firm is either minimizing losses or maximizing profit in the short run if it
produces where MC = P above minimum AVC for any price above minimum AVC, the
quantity can simply be read off the MC curve. Thus the MC curve above minimum AVC
becomes the firms short-run supply curve.
192. Explain why Adam Smith believed that competitive markets are a key component of
achieving the gains from the invisible hand.
ANSWER E, R
Adam Smith believed that individuals acting in their own self-interest would end up
acting in societys best interest. This process is borne out by competition, in which firms
pursuing maximum profit end up producing a good at the lowest possible AC and selling
it at a price equal to the minimum LRAC.
193. Explain how the short-run industry supply curve for a perfectly competitive market is
derived.
ANSWER E, A
At any given price, the quantities supplied by individual firms are simply added. The
resulting curve is a horizontal summation of all the individual firms supply curves.
194. Explain why taxes on pollutants reduce pollution while subsidies to firms cutting their
pollutants actually increase pollution.
ANSWER M, I
Taxes cause an increase in cost and a leftward shift of supply. Output decreases and there
is less pollution. Subsidies cause individual firms to cut their emissions, but they also
induce additional firms into the market. Since costs of production decrease, the new
equilibrium output will increase.
195. Show what happens to the industry equilibrium when new firms enter a perfectly
competitive market in the long run.
ANSWER M, A
The diagram of the process should be similar to Figure 8-7 in the text. The industry supply
curve shifts outward and industry price falls.

Chapter 8/The Firm and the Industry Under Perfect Competition 39


196. What is the relationship between the long-run industry supply curve and the short-run
supply curve in a perfectly competitive market?
ANSWER M, A
The long-run industry supply curve evolves from the short-run supply curve. As new
firms enter, the short-run supply curve shifts toward its long-run position. Also, as shortrun fixed cost commitments become variable, the short-run cost curves become the longrun cost curve.
197. To own a taxicab in New York City, you must own a medallion. New York City regulates
the number of official cabs by limiting the number of medallions. Explain why the New
York cab industry is not competitive by reviewing the four conditions necessary for
competition. NYC violates which one?
ANSWER E, I
Production is by many firms, each selling an identical product. There are no barriers to
entry or exit, and consumers and producers have perfect information. The medallion is a
barrier to entry to new firms, which can only enter the industry by buying a medallion
from existing taxicab owners.
198. What is the difference between the accountants concept of profit and the economists view
of profit?
ANSWER E, A
Accountants tend to include in TC contractual costs only. The economist measures TC as
the cost of all the firms inputs, including the opportunity cost of the capital or any other
inputs, such as labor, provided by the firms owners. Accounting profit is generally larger
than economic profit, so that positive accounting profit may correspond to zero economic
profit.
199. Illustrate the cost curves and average revenue (demand) curve for the perfectly competitive
firm in long-run equilibrium.
ANSWER E, I
The illustration should look like Figure 8-9(a) in the text.
200. Why do economists consider perfect competition to be the most efficient market structure?
ANSWER E, R
Perfect competition is the most efficient market structure because, in the long run, each
firm in the market will be producing at its minimum average cost, or per-unit cost (see
Figure 8-9a in the text, for example). This means that consumers get desired goods and
services at the lowest possible prices, and also that the firms are economizing on societys
scarce resources to the greatest extent possible.