5_Market Equilibrium and the Perfect Competition Model

Question 1

State the assumptions underlying the concept of perfect competition.

Answer 1

1. Large number of buyers and sellers
2. Standardized product
3. Producers are price takers
4. Easy entry and exit

Question 2

___ is the difference between the total amount that consumers are willing and able to pay for a good or service and the total amount that they actually do pay; the area under the demand curve down to the horizontal line corresponding to the
price being charged.

Answer 2

Consumer surplus

Question 3

___ is the difference between how much of a good the producer is willing to supply versus how much he receives in the trade; the benefit the producer receives for selling the good in the market.

Answer 3

Producer surplus

Question 4

___ is a situation in which nothing can be improved without something else being hurt; implies an economic state in which every resource is optimally allocated to serve each individual or entity in the best way while minimizing waste and inefficiency.

Answer 4

Economic efficiency

Question 5

___ is an idealistic market structure which has four characteristics: (1) large number of buyers, (2) large number of sellers, (3) perfect information about the market, (4) unrestricted entry and exit in the long-run.

Answer 5

Perfect competition

Question 6

___ is the gap between total revenue and total cost; the point on a cost curve where marginal cost and marginal revenue intersect.

Answer 6

Profit

P=MR=MC

Question 7

Assuming perfect competition, profit in the short-run is ___.

Answer 7

Good

Positive economic profit

Question 8

Assuming perfect competition, loss in the short-run is ___.

Answer 8

Bad

Negative economic profit

Question 9

If a firm is incurring an economic loss that it believes is temporary, it will ___.

Answer 9

Produce at a loss or temporarily shut down

Question 10

___ is a cost that has already been committed and cannot be recovered; irrelevant to decision making must be paid whether it produces or shuts down.
I.e., total fixed costs

Answer 10

Sunk cost

Question 11

___ is the output at the level where price and average variable costs are equal.

Answer 11

Shutdown quantity

Question 12

___ is the price at which a firm shuts down.

Answer 12

Shutdown price

Question 13

Assuming perfect competition, in the short-run, the supply curve of a firm is ___.

Answer 13

Upward sloping

Question 14

Assuming perfect competition, in the short-run, the supply curve of the market is ___.

Answer 14

Horizontal

Question 15

Assuming perfect competition, in the ___-run, firms are allowed to enter or exit a market.

Answer 15

Long-run

Question 16

Assuming perfect competition, in the ___-run, firms are not allowed to enter or exit a market.

Answer 16

Short-run

Question 17

Assuming perfect competition, if existing firms earn a positive economic profit, new firms enter the market, market supply shifts ___ and price ___.

Answer 17

Shifts RIGHT

Price DECREASES

Question 18

Assuming perfect competition, if existing firms earn a negative economic profit, new firms enter the market, market supply shifts ___ and price ___.

Answer 18

Shifts LEFT

Price INCREASES

Question 19

___ is revenue minus all costs, including implicit costs like opportunity costs.

Answer 19

Economic profit

Question 20

___ reflects the behavior of buyers in a market while ___ reflects how much a consumer is willing and able to purchase at a given price.

Answer 20

Demand

Qd

Question 21

___ is reflected by a movement along a demand curve while ___ is a shift in the demand curve.

Answer 21

ΔQd

ΔDemand

Question 22

___ reflects the behavior of sellers in a market while ___ reflects how much a seller is willing and able to sell at a given price.

Answer 22

Supply

Qs

Question 23

___ is reflected by a movement along a supply curve while ___ is a shift in the supply curve.

Answer 23

ΔQs

ΔSupply

Question 24

___ occurs when the Qd equals the Qs; where equilibrium price equals the equilibrium quantity.

Answer 24

Market equilibrium

Question 25

___ occurs when demand is higher than supply.

Answer 25

Shortage

Question 26

___ occurs when demand is lower than supply.

Answer 26

Surplus

Question 27

___ is the division of the burden of a tax between the buyer and the seller.

Answer 27

Tax incidence

Question 28

___ is the deadweight loss caused by a tax.

Answer 28

Excess burden of tax

Question 29

___ is when the tax revenue and the deadweight loss are equal.

Answer 29

Burden of tax

Question 30

For a given elasticity of supply, the buyer pays a larger share of the tax, the more ___ is the demand for the good.

Answer 30

Inelastic

Question 31

For a given elasticity of demand, the seller pays a larger share of the tax, the more ___ is the supply of the good.

Answer 31

Inelastic

Question 32

Excess deadweight loss is (larger/smaller), the more inelastic is demand or supply.

Answer 32

Smaller

Question 33

Perfectly Inelastic Demand: ___ Pays the whole tax and Efficient

Answer 33

Buyer

Question 34

Perfectly Elastic Demand: ___ Pays the whole tax and Inefficient

Answer 34

Seller

Question 35

Perfectly Inelastic Supply: ___ Pays the whole tax and Efficient

Answer 35

Seller

Question 36

Perfectly Elastic Supply: ___ Pays the whole tax and Inefficient

Answer 36

Buyer

Question 37

A ___ or price cap is a government regulation that places an upper limit on the price at which a particular good, service, or factor of production may be traded.

Answer 37

Price ceiling

Question 38

If a price ceiling set below market equilibrium, there would be also be a ___; inefficient ceiling.

Answer 38

DEADWEIGHT LOSS because of the shortage

Question 39

A ___ is a government regulation that places a lower limit on the price at which a particular good, service, or factor of production may be traded.

Answer 39

Price floor

Question 40

If a price floor set below market equilibrium, there would be also be ___; inefficient ceiling.

Answer 40

No effect

Question 41

If a price floor set above the market equilibrium level, it is ___.

Answer 41

Inefficient

Question 42

A ___ is a price floor in an agricultural market maintained by a government guarantee to buy any surplus output at that price.
I.e., the government buys a surplus when a price floor is below the equilibrium price.

Answer 42

Price support

Question 43

A ___ is a payment by the government to a producer to cover part of the cost of production.
I.e., when the government buys a surplus produced by farmers.

Answer 43

Subsidy

Question 44

If a price support set below market equilibrium, there would be also be ___; inefficient ceiling.

Answer 44

No effect

Question 45

A ___ assumes that even in a monopoly or oligopoly, the existing companies will behave competitively when there is a lack of barriers, such as government regulation and high entry costs, to prevent new companies from entering the market.

Answer 45

Contestable market

Question 46

A __ occurs when a company offers a relatively low price to stimulate demand and gain market share.

Answer 46

Cost strategy

Question 47

___ is a steady pursuit of new product variants that will be prized by the consumer with the intent of extending the opportunity for an above-normal profit; important to commit early in differentiation.

Answer 47

Product differentiation strategy

Question 48

The ___ model allows for some differentiation in a product and the opportunity to charge a higher price because buyers are willing to pay a premium.

Answer 48

Monopolistic competition model

Question 49

A ___ endeavors to take advantage of market segmentation.

I.e., focus a strategy geared towards one segment of the market or another.

Answer 49

Focus strategy

Question 50

___ assumes a competitive advantage by having the lowest cost of operation in the industry and is driven by company efficiency, size, scale, scope and cumulative experience (learning curve).

Answer 50

Cost leadership strategy

Question 51

If a producer is not able to expand its plant capacity immediately, it is

a. bankrupt.
b. operating in the long run.
c. operating in the short run.
d. losing money.

Answer 51

c. operating in the short run.

Question 52

Assume the market for organically-grown produce is perfectly competitive. All else equal, as farmers find it less profitable to produce and sell organic produce in this market

a. the supply curve will shift to the right, the demand curve will shift to the left, and the equilibrium price will decrease.
b. the supply curve will shift to the left, the demand curve will shift to the left, and the equilibrium price will increase.
c. the demand curve will shift to the left and the equilibrium price will decrease.
d. the supply curve will shift to the left and the equilibrium price will increase.

Answer 52

d. the supply curve will shift to the left and the equilibrium price will increase.

Question 53

Assume that both the demand curve and the supply curve for MP3 players shift to the right but the demand curve shifts more than the supply curve. As a result

a. the equilibrium price of MP3 players will decrease; the equilibrium quantity may increase or decrease.
b. the equilibrium price of MP3 players may increase or decrease; the equilibrium quantity will increase.
c. the equilibrium price of MP3 players will increase; the equilibrium quantity may increase or decrease.
d. both the equilibrium price and quantity of MP3 players will increase.

Answer 53

d. both the equilibrium price and quantity of MP3 players will increase.

Question 54

Which of the following would cause an increase in the equilibrium price and an increase in the equilibrium quantity of watermelons?

Select one:

a. an increase in supply and an increase in demand greater than the increase in supply
b. an increase in supply
c. a decrease in demand and an increase in supply
d. an increase in demand and an increase in supply

Answer 54

a. an increase in supply and an increase in demand greater than the increase in supply

Question 55

A monopolistically competitive firm will

Select one:

a. charge the same price as its competitors do.
b. always produce at the minimum efficient scale of production.
c. have some control over its price because its product is differentiated.
d. produce an output level that is productively and allocatively efficient.

Answer 55

c. have some control over its price because its product is differentiated.

Question 56

An increase in input costs in the production of electric automobiles caused the price of electric automobiles to rise. Holding everything else constant, how would this affect the market for gasoline-powered automobiles (a substitute for electric automobiles)?

a. The demand for gasoline-powered automobiles would increase and the equilibrium price of gasoline-powered automobiles would increase.
b. The demand for gasoline-powered automobiles would decrease because consumers could afford to buy fewer gasoline-powered automobiles.
c. The demand for gasoline-powered automobiles would increase and the equilibrium price of gasoline-powered automobiles would decrease.
d. The supply of gasoline-powered automobiles would increase and the equilibrium price of gasoline-powered automobiles would decrease.

Answer 56

a. The demand for gasoline-powered automobiles would increase and the equilibrium price of gasoline-powered automobiles would increase.

Why?

Question 57

A perfectly competitive firm produces 3,000 units of a good at a total cost of $36,000. The fixed cost of production is $20,000. The price of each good is $10. Should the firm continue to produce in the short run?

a. No, it should shut down because it is making a loss.
b. Yes, it should continue to produce because it is minimizing its loss.
c. There is insufficient information to answer the question.
d. Yes, it should continue to produce because its price exceeds its average fixed cost.

Answer 57

b. Yes, it should continue to produce because it is minimizing its loss.

Why?

Question 58

Max Shreck, an accountant, quit his $80,000-a-year job and bought an existing tattoo parlor from its previous owner, Sylvia Sidney. The lease has five years remaining and requires a monthly payment of $4,000. Max’s explicit cost amounts to $3,000 per month more than his revenue. Should Max continue operating his business?

a. Max should continue to run the tattoo parlor until his lease runs out.
b. If Max’s marginal revenue is greater than or equal to his marginal cost, then he should stay in business.
c. This cannot be determined without information on his revenue.
d. Max’s explicit cost exceeds his total revenue. He should shut down his tattoo parlor.

Answer 58

a. Max should continue to run the tattoo parlor until his lease runs out.

Why?

Question 59

A perfectly competitive firm’s short-run supply curve is

a. perfectly elastic at the market price.
b. horizontal at the minimum average total cost.
c. upward sloping and is the portion of the marginal cost curve that lies above the average variable cost curve.
d. upward sloping and is the portion of the marginal cost curve that lies above the average total cost curve.

Answer 59

c. upward sloping and is the portion of the marginal cost curve that lies above the average variable cost curve.

Why?

Question 60

If a typical firm in a perfectly competitive industry is earning profits, then

a. new firms will enter in the long run causing market supply to decrease, market price to rise and profits to increase.
b. the number of firms in the industry will remain constant in the long run.
c. all firms will continue to earn profits.
d. new firms will enter in the long run causing market supply to increase, market price to fall and profits to decrease.

Answer 60

d. new firms will enter in the long run causing market supply to increase, market price to fall and profits to decrease.

Why?

Question 61

A perfectly competitive wheat farmer in a constant-cost industry produces 3,000 bushels of wheat at a total cost of $36,000. The prevailing market price is $15. What will happen to the market price of wheat in the long run?

a. The price rises above $15.
b. The price falls to $12.
c. The price remains constant at $15.
d. There is insufficient information to answer the question.

Answer 61

b. The price falls to $12.

36,000 / 3,000 = $12

Question 62

The reason that the coffeehouse market is monopolistically competitive rather than perfectly competitive is because

a. barriers to entry are very low.
b. entry into the market is blocked.
c. products are differentiated.
d. there are many firms in the market.

Answer 62

c. products are differentiated.

Why?

Question 63

Economists have long debated whether there is a significant loss of well-being to society in markets that are monopolistically competitive rather than perfectly competitive. Which of the following offers the best reason why some economists believe that monopolistically competitive markets benefit consumers despite any loss of well-being?

a. Although consumers may pay a price greater than marginal cost and the product is not produced at minimum average total cost, they benefit from being able to buy a differentiated product more closely suited to their tastes.
b. Although consumers may pay a price greater than marginal cost for a product, the product is produced at the minimum average total cost.
c. Consumers pay a price equal to the marginal cost of producing a product, even though it is not produced at the minimum average total cost.
d. Consumers are better off choosing from a variety of differentiated products, even though product differentiation causes barriers that restrict entry into monopolistically competitive markets.

Answer 63

a. Although consumers may pay a price greater than marginal cost and the product is not produced at minimum average total cost, they benefit from being able to buy a differentiated product more closely suited to their tastes.

Why?

Question 64

When a credit card company offers different services with its card, like travel insurance for air travel tickets purchased with the credit card or product insurance for items purchased with the card, the credit card company is trying to

a. shift the demand curve for competing firms to the right.
b. convince customers that its card has greater value than those offered by rival firms.
c. create a barrier to entry for competing firms.
d. create a perfectly competitive market in which to sell its credit card.

Answer 64

b. convince customers that its card has greater value than those offered by rival firms.

Why?

Question 65

Juicy Couture has been successful in selling women’s clothing using an unusual strategy.

According to an article in the Wall Street Journal, the key to the firm’s strategy is to “limit distribution to maintain the brand’s exclusive cachet, even if that means sacrificing sales, a brand-management technique once used only for high-end luxury brands.” In 2006, Juicy clothes were sold in only four department stores: Neiman Marcus, Saks, Bloomingdale’s, and Nordstrom. In 2006, its sales have more than quadrupled since 2002.

Source: Rachel Dodes, “From Track Suits to Fast Track,” Wall Street Journal, September 13, 2006.

How does limiting the number of stores in which Juicy’s products are sold contribute to its success?

a. By sacrificing sales, the company was able to focus on producing high quality products.
b. It helps establish Juicy’s products as luxury items favored by the very wealthy.
c. Maintaining the exclusivity of a product increases the demand for the product.
d. It enables Juicy to price its products at a premium and differentiate them from lower priced products.

Answer 65

d. It enables Juicy to price its products at a premium and differentiate them from lower priced products.

Question 66

Which of the following statements is true about advertising by a monopolistically competitive firm?

a. Advertising will be more beneficial if a monopolistic competitor colludes with other firms to advertise the products of the industry as a whole rather than an individual firm’s product.
b. Advertising could make the monopolistic competitor’s demand more inelastic, but advertising has no effect on a perfect competitor’s demand.
c. Since the monopolistic competitor, like the perfect competitor, makes zero profit in the long run, it is a waste of resources to advertise its products.
d. Monopolistically competitive firms tend to shun advertising because advertising draws attention to the variety of differentiated products available in the industry.

Answer 66

b. Advertising could make the monopolistic competitor’s demand more inelastic, but advertising has no effect on a perfect competitor’s demand.

Question 67

One of your classmates asserts that advertising, marketing research, and brand management are redundant expenditures because a firm can obtain the same information by simply looking at what customers are already buying. Which of the following is not a response you might offer her?

a. Marketing research could allow a firm to identify new market opportunities and at least, in the short run, a firm can make a profit supplying products to this market segment.
b. Advertising and brand management allow a firm to create an entry barrier which will insulate the firm from competition and from undertaking further product innovations.
c. Conducting market research is a good way for firms to keep abreast of changing consumer tastes and preferences.
d. If a firm successfully manages its brand, customers become less price sensitive as they perceive fewer substitutes for the firm’s brand.

Answer 67

b. Advertising and brand management allow a firm to create an entry barrier which will insulate the firm from competition and from undertaking further product innovations.

Question 68

A company’s competitive strategy deals with

a. how to compete successfully-its plans for positioning the company in the marketplace, its specific efforts to please customers and improve its competitive strength, and the type of competitive advantage it intends to establish.
b. its plans for under-pricing rivals and achieving product superiority.
c. the specific actions management plans to take to gain a competitive advantage over rivals
d. the specific actions management intends to take to strongly differentiate its product offering from the offerings of rival companies in the industry.
e. how it plans to unify its functional and operating strategies into a cohesive effort aimed at successfully taking customers away from rivals.

Answer 68

a. how to compete successfully-its plans for positioning the company in the marketplace, its specific efforts to please customers and improve its competitive strength, and the type of competitive advantage it intends to establish.

Question 69

A competitive strategy of striving to be the low-cost provider is particularly attractive when

a. most rivals are pursuing best-cost or broad differentiation strategies.
b. buyers are not swayed by advertising and are not very brand-loyal.
c. most rivals are trying to differentiate their product offering from those of rivals.
d. there are many ways to achieve higher product quality that have value to buyers.
e. buyers are large, have significant power to bargain down prices, use the product in much the same ways, and have common user requirements.

Answer 69

e. buyers are large, have significant power to bargain down prices, use the product in much the same ways, and have common user requirements.

Question 70

To be successful with a differentiation strategy, a company has to

a. outspend rivals on R&D in order to have differentiating attributes that rivals don’t have.
b. have a state-of-the-art value chain and concentrate on providing buyers with a technologically superior product
c. incorporate more differentiating features into its product/service offering than rivals and also charge a price no higher than the prices charged by rivals.
d. study buyers” needs and behavior very carefully to learn what they consider important, what they think has value, and what they are willing to pay for
e. Concentrate on differentiating its product on the basis of superior product quality or personalized customer service.

Answer 70

d. study buyers” needs and behavior very carefully to learn what they consider important, what they think has value, and what they are willing to pay for