ECON101 Unit 9

Question 1

What is perfect competition and what are its main traits?

Answer 1

• Many firms sell an identical good/service
• Many perfect substitutes
• Many buyers and sellers (well informed on prices)
• No restrictions to entry
• Established firms have no advantage over new ones

Question 2

Is each firm a price taker in perfect competition?

Answer 2

Each is a price taker and cannot influence market price

• must take equilibrium price
• each produces small amount of total output
• perfect substitutes
• output is perfectly elastic by all firms

Question 3

Why must firms accept market price?

Answer 3

If a firm lowers the price = economic loss

If a firm raises the price = consumers will not buy

Question 4

How does the demand curve look in a perfectly competitive market?

Answer 4

Downward sloping

Question 5

What is the firms marginal revenue?

Answer 5

MR = market price

Question 6

What is the goal of each firm?

Answer 6

Maximize economic profit (total revenue-total cost)

Question 7

How to find profit maximizing output?

Answer 7

Look at firms total revenue and total cost curves

Low/high output = economic loss
Intermediate output = economic profit

Question 8

When is profit maximized?

Answer 8

Marginal revenue = marginal cost

Question 9

What happens when a firm makes an economic loss?

Answer 9

Needs to decide to stay or exit:

If it stays… must decide whether to produce or shutdown temporarily

Question 10

What is the shutdown point?

Answer 10

Price and quantity at which it is indifferent between producing profit maximizing quantity and shutting down

Question 11

Where is the shutdown point?

Answer 11

At the minimum average variable cost (AVC)

• At this point the firm incurs a loss = to the TFC
• A firm shuts down if it is below the AVC

Question 12

What is a short run market supply curve?

Answer 12

the quantity supplied by all firms in the market at each price

Question 13

What does the market supply curve look like at shutdown point?

Answer 13

• Marginal cost curve above shutdown point
• Some will produce shutdown quantity and others will produce 0
• Market supply curve is horizontal

Question 14

Market supply curve: Change in demand

Answer 14

Increase: right shift, price rises, quantity increases
Decrease: left shift, price falls, quantity decreases

Question 15

Three profit maximizing outcomes in short run:

Answer 15

1) Break even: Price = ATC
2) Positive profit: Price exceeds ATC
3) Negative profit (loss): Price is less than ATC

Question 16

What happens in the long-run?

Answer 16

In equilibrium… firms break even b/c firms can enter or exit market

Question 17

What happens in long-run in terms of entry/exit?

Answer 17

• Firms exit if economic loss
• Firms enter if existing firms are making profit (market price greater than ATC)
• Price goes down, supply increases when more firms enter
• ATC exceeds MR = firms incur economic loss

Question 18

Long-run: What happens when markets have an economic loss and an incentive to leave?

Answer 18

• Supply decreases, price rises
• Firms exit as long as firms are incurring loss
• In long run, price rises until firms make 0 economic profit

Question 19

How does increase or decrease in demand affect exiting and entering?

Answer 19

Increase:

• Firms making profit,
• Induces firms to enter increasing supply, prices fall
• Economic profit falls
• Eventually balances and firms make 0 profit = firms no longer enter

Decrease:

• Firms incurring losses/ inducing exit
• Supply decreases, price rises
• Firms increase output
• 0 economic profit, no incentive to exit

Question 20

Technological advances affect:

Answer 20

• First firms use it to make profit
• As more firms use, market supply increases and price falls
• New tech, more entry
• Lower price, old technology firms incur loss
• All firms use technology = 0 economic profit

Question 21

What is an efficient use of resources?

Answer 21

When no one can be made better off without making someone worse off