Practice Set 5

8.1 Perfectly Competitive Markets

1) A price taker is
A) a firm that accepts different prices from different customers.
B) a consumer who accepts different prices from different firms.
C) a perfectly competitive firm.
D) a firm that cannot influence the market price.
E) both C and D
Answer: E
3) Which of following is a key assumption of a perfectly competitive market?
A) Firms can influence market price.
B) Commodities have few sellers.
C) It is difficult for new sellers to enter the market.
D) Each seller has a very small share of the market.
E) none of the above
Answer: D

4) Several years ago, Alcoa was effectively the sole seller of aluminum because the firm
owned nearly all of the aluminum ore reserves in the world. This market was not perfectly
competitive because this situation violated the:
A) price-taking assumption.
B) homogeneous product assumption.
C) free entry assumption.
D) A and B are correct.
E) A and C are correct.
Answer E

6) Firms often use patent rights as a:

A) barrier to exit.
B) barrier to entry.
C) way to achieve perfect competition.
D) none of the above
Answer: B
7) A few sellers may behave as if they operate in a perfectly competitive market if the market
demand is:
A) highly inelastic.
B) very elastic.
C) unitary elastic.
D) composed of many small buyers.
Answer: B

8.2 Profit Maximization

1) If managers do not choose to maximize profit, but pursue some other goal such as revenue
maximization or growth,
A) they are more likely to become takeover targets of profit-maximizing firms.
B) they are less likely to be replaced by stockholders.
C) they are less likely to be replaced by the board of directors.
D) they are more likely to have higher profit than if they had pursued that policy explicitly.
E) their companies are more likely to survive in the long run.
Answer: A

3) The textbook for your class was not produced in a perfectly competitive industry because
A) there are so few firms in the industry that market shares are not small, and firms' decisions
have an impact on market price.
B) upper-division microeconomics texts are not all alike.
C) it is not costless to enter or exit the textbook industry.
D) of all of the above reasons.
Answer: D

5) The "perfect information" assumption of perfect competition includes all of the following
except one. Which one?
A) Consumers know their preferences.
B) Consumers know their income levels.
C) Consumers know the prices available.
D) Consumers can anticipate price changes.
E) Firms know their costs, prices and technology.
Answer: D

8) In many rural areas, electric generation and distribution utilities were initially set up as
cooperatives in which the electricity customers were member-owners. Like most
cooperatives, the objective of these firms was to:
A) maximize profits for the member-owners.
B) maximize total revenue that could be redistributed to the member-owners.
C) operate at zero profit in order to provide low electricity prices for the member-owners.
D) minimize the costs of production.
Answer: C

8.3 Marginal Revenue, Marginal Cost, and Profit Maximization

1) Revenue is equal to
A) price times quantity.
B) price times quantity minus total cost.
C) price times quantity minus average cost.
D) price times quantity minus marginal cost.
E) expenditure on production of output.
Answer A

3) A firm maximizes profit by operating at the level of output where

A) average revenue equals average cost.
B) average revenue equals average variable cost.
C) total costs are minimized.
D) marginal revenue equals marginal cost.
E) marginal revenue exceeds marginal cost by the greatest amount.
Answer D

4) At the profit-maximizing level of output, what is relationship between the total revenue
(TR) and total cost (TC) curves?
A) They must intersect, with TC cutting TR from below.
B) They must intersect, with TC cutting TR from above.
C) They must be tangent to each other.
D) They cannot be tangent to each other.
E) They must have the same slope.
Answer A

6) If current output is less than the profit-maximizing output, then the next unit produced
A) will decrease profit.
B) will increase cost more than it increases revenue.
C) will increase revenue more than it increases cost.
D) will increase revenue without increasing cost.
E) may or may not increase profit.
Answer: C

10) The demand curve facing a perfectly competitive firm is

A) the same as the market demand curve.
B) downward-sloping and less flat than the market demand curve.
C) downward-sloping and more flat than the market demand curve.
D) perfectly horizontal.
E) perfectly vertical.
Answer: D

13) Because of the relationship between a perfectly competitive firm's demand curve and its
marginal revenue curve, the profit maximization condition for the firm can be written as
A) P = MR.
B) P = AVC.
C) AR = MR.
D) P = MC.
E) P = AC.
Answer D

Choosing ouput in the short run

10) Bette's Breakfast, a perfectly competitive eatery, sells its "Breakfast Special" (the only
item on the menu) for $5.00. The costs of waiters, cooks, power, food etc. average out to
$3.95 per meal; the costs of the lease, insurance and other such expenses average out to $1.25
per meal. Bette should
A) close her doors immediately.
B) continue producing in the short and long run.
C) continue producing in the short run, but plan to go out of business in the long run.
D) raise her prices above the perfectly competitive level.
E) lower her output.

33) Conigan Box Company produces cardboard boxes that are sold in bundles of 1000 boxes.
The market is highly competitive, with boxes currently selling for $100 per thousand.
Conigan's total and marginal cost curves are:
TC = 3,000,000 + 0.001Q2
MC = 0.002Q
where Q is measured in thousand box bundles per year.
a. Calculate Conigan's profit maximizing quantity. Is the firm earning a profit?
b. Analyze Conigan's position in terms of the shutdown condition. Should Conigan operate
or shut down in the shortrun?
Answer:
a.
Given the competitive nature of the industry, Conigan should equate P to MC.
100 = 0.002Q
Q = 50,000
To determine profit:
π = TR - TC
TR = PQ
TR = $100 ∙ 50,000
TR = 5,000,000
TC = 3,000,000 + 0.001(50,000)2
TC = 3,000,000 + 2,500,000
TC = 5,500,000
π = 5,000,000 - 5,500,000
π = -500
Conigan is losing $500,000 per year.

b.
To determine if the firm should operate or shutdown in the short run, we must compare P to
AVC.

AVC =
TVC = TC - TFC
TVC = 5,500,000 - 3,000,000
TVC = 2,500,000

AVC = = $50
AVC = 50;P = $100
The firm should operate since P > AVC.

17) Assume the market for tortillas is perfectly competitive. The market supply and demand
curves for tortillas are given as follows:
supply curve:
P = .000002Q demand curve: P = 11 - .00002Q
The short run marginal cost curve for a typical tortilla factory is:
MC = .1 + .0009Q

a. Determine the equilibrium price for tortillas.

b. Determine the profit maximizing short run equilibrium level of output for a tortilla
factory.
c. At the level of output determined above, is the factory making a profit, breaking-even, or
making a loss? Explain your answer.
d. Assuming that all of the tortilla factories are identical, how many tortilla factories are
producing tortillas?

Answer:
a.
The equilibrium price is the price at which the quantity supplied equals the quantity
demanded. Therefore,
.000002Q = 11 - .00002Q
Q = 500,000
P=1

b.
The profit maximizing short run equilibrium level of output for a tortilla factory is found
where marginal revenue equals marginal cost. For a perfectly competitive firm, marginal
revenue equals price. Therefore,
P = MC
1 = .1 + .0009Q
Q = 1,000

c.
Given the information provided, it cannot be determined whether the firm is making a profit
or a loss, because total cost cannot be determined from marginal cost.

d.
Since Q = 500,000 and Q = 1,000, there must be 500 firms.