Micro exam 2 8

Question 1

Basic Characteristics of Perfectly Competitive Market and examples of Perfect Competition market

Answer 1

Numerous small firms and consumers
* Each one - a negligible part of the whole market
* Each firm’s decisions have no effect on market price [price-
taker]
Freedom of entry and exit
* New firms can easily enter and compete with older firms
* No barriers prevent firms from leaving the market
* Profit potential can drive new firms to enter in the long-run
* Loss will make existing firms to exit the market in the long-run
4.Perfect information
* Firms and customers - well informed about available products and
prices
Examples:Agricultural markets, Basic metals, Widely traded corporate stocks,
and Foreign exchange

Question 2

2. Why is a Firm in a Competitive market considered a Price-Taker?

Answer 2

Firm that faces a given market price
* Individual Quantity supplied has no effect on that price
* Perfectly competitive firm that decides to produce
* Must accept, or “take,” the market price
* Cannot charge a price higher than the market price
* Cannot charge a price lower than the market price
* The demand curve for a perfectly competitive firm is horizontal
[Perfectly elastic].
* Ed = ∞

Question 3

How is the Price that the competitive firm charges decided?

Answer 3

Firms must look for the output level that maximizes profit.
* Rule: Increase the level of output if price is greater than
marginal cost.
* Stop increasing output when price equals marginal cost
* Total revenue (TR) Total cost(TC) Profit = TR – TC
* If TR > TC, economic profit If TC > TR, economic loss

Question 4

4. Calculation of Total Revenue, Average Revenue, and Marginal Revenue for a competitive firm

Answer 4

Average revenue AR
* Total revenue divided by quantity
* MR = P = AR
* Along a perfectly competitive firm’s demand curve

Question 5

6. Why is the Firm’s Demand curve horizontal in shape?

Answer 5

The horizontal demand curve indicates that the elasticity of demand for the good is perfectly elastic. This means that if any individual firm charged a price slightly above market price, it would not sell any products.

Question 6

How do firms in the PC market decide on profit-maximizing output? How do they determine the
price?

Answer 6

Firms in perfect competition are price takers. This means they have no ability to set their own price and must accept the price set by the market. Their profit-maximizing decision, therefore, boils down to choosing a profit-maximizing level of production (q*) given the market price (P)

Question 7

Graphically as well as using tables analyze how much a Firm in the PC market will produce to
maximize profit. How do we obtain the maximizing level of profit from the graph?

Answer 7

In summary, the maximizing level of profit for a perfectly competitive firm occurs where MR equals MC, whether analyzed graphically or through tabular data

Question 8

9. What happens to the firm’s demand curve when the market price changes?

Answer 8

The demand curve generally slopes down from left to right, due to the law of demand while the quantity demanded drops as the price rises for the majority of goods.

Question 9

Why is the Individual Firm’s Supply curve in the PC market represented by the Marginal Cost
curve?

Answer 9

In summary, the individual firm’s supply curve coincides with its marginal cost curve in a perfectly competitive market, ensuring efficient allocation of resources and equilibrium.

Question 10

11. How do we obtain Market Supply from Individual firm’s supply in a competitive market?

Answer 10

Market supply is obtained by adding together the individual supplies of all the firms in the economy.

Question 11

Does the profit-maximizing price and quantity guarantee a positive economic profit for the firms
in the short run?

Answer 11

When price is equal to average cost, economic profits are zero. Thus, although a monopolistically competitive firm may earn positive economic profits in the short term, the process of new entry will drive down economic profits to zero in the long run.

Question 12

If in the short run, a firm in a Perfectly competitive market faces economic loss should it continue
in the market or shut down production?

Answer 12

In this scenario, the firm covers its variable costs but still falls short of covering its total costs.
Essentially, the firm minimizes its losses by producing at a level where P = AVC.
Continuing production allows the firm to maintain some revenue and mitigate the immediate impact of losses.

Question 13

14. What motivates new firms to enter the PC market in the long run?

Answer 13

The existence of economic profits in a particular industry attracts new firms to the industry in the long run. As new firms enter, the supply curve shifts to the right, price falls, and profits fall.

Question 14

15. What motivates existing firms to exit the PC market in the long run?

Answer 14

zero economic profit

Question 15

16. What happens to market price and quantity as new firms enter the market in the long run?

Answer 15

Entry of many new firms causes the market supply curve to shift to the right. As the supply curve shifts to the right, the market price starts decreasing, and with that, economic profits fall for new and existing firms.

Question 16

What happens to the market price and quantity when existing firms exit the market in the long
run?

Answer 16

Exit of many firms causes the market supply curve to shift to the left. As the supply curve shifts to the left, the market price starts rising, and economic losses start to be lower.

Question 17

Why does every firm in the competitive market earn zero or normal profit in the long run?

Answer 17

In a perfectly competitive market, firms can only experience profits or losses in the short run. In the long run, profits and losses are eliminated because an infinite number of firms are producing infinitely divisible, homogeneous products.

Question 18

15. What motivates existing firms to exit the PC market in the long run?

Answer 18

The long-run industry supply curve represents the quantity of goods or services that firms in a perfectly competitive industry are willing and able to produce at various prices in the long run.

Question 19

Constant cost industry

Answer 19

-uses such a small portion of the resources available that expanding injury output does not bud up resource prices
-long run supply curve for the industry, S* is a straight horizontal line
EX-Pencil industry

Question 20

increasing cost industry

Answer 20

An increasing-cost industry is a perfectly competitive industry with a positively-sloped long-run industry supply curve This means that the prices of factors increase as the industry output expands This happens because the entry of new firms, prompted by an increase in demand, causes the long-run average cost curve of each firm to shift upward

Question 21

decreasing cost industry

Answer 21

A decreasing-cost industry is characterized by
The cost of an item declines as its production increases.
It has a downward-sloping, long-run supply curve.
Expansion of industry output decreases firm’s cost curves due to the entry of new firms.
Falling costs of production lead to lower product prices.

Question 22

Is the Perfectly competitive market Productively efficient in the long run?

Answer 22

In the long run, a perfectly competitive market achieves both productive efficiency and allocative efficiency. Let’s break down what these terms mean:

Question 23

Why is a Perfectly competitive market considered Socially optimal?

Answer 23

When perfectly competitive firms follow the rule that profits are maximized by producing at the quantity where price is equal to marginal cost, they are thus ensuring that the social benefits received from producing a good are in line with the social costs of production.

Question 24

If the Government imposes any binding price ceiling or price floor how does it impact the
competitive markets Total surplus? [Dead-weight loss]

Answer 24

In summary, both price ceilings and price floors can distort market outcomes, affecting total surplus and leading to deadweight loss. The specific impact depends on whether the regulation is binding and its position relative to the equilibrium price.

Question 25

A firm in a perfectly competitive market:

Answer 25

must take the price that is determined in the market.

Question 26

In the perfectly competitive market, individual firms exert no effect on the market price. Therefore, the firm’s marginal revenue is:

Answer 26

the same as the firm’s demand curve.

Question 27

If a firm in a competitive industry is making zero economic profit but still producing, it must be the case that:

Answer 27

ATC=MR=MC

Question 28

Demand increases in an increasing-cost industry that is initially in long-run competitive equilibrium. After full adjustment, price will be

Answer 28

above its original level

Question 29

As firms exit an industry, the industry supply curve shifts __________ and the equilibrium price __________ until long-run competitive equilibrium is established and the surviving firms are earning __________ economic profits.

Answer 29

leftward, rises , zero

Question 30

A perfectly competitive firm faces a __________ demand curve.

Answer 30

perfectly elastic

Question 31

At Nick’s Bakery, the cost of making one danish is $1.00. If Nick sells 20 danishes and gains producer surplus of $40.00, then Nick must be selling his danishes for

Answer 31

$3 each
20x1=20
ps=40 20x3=60-20=40
so 3

Question 32

If new firms enter a perfectly competitive industry seeking economic profit and begin supplying goods in the market, which of the following will occur?

Answer 32

The market supply curve will shift rightward.

Question 33

Nick and Laura sell lemonade on the corner for $2.10 per cup. It costs them $0.10 to make each cup. On a certain day, their producer surplus is $40. How many cups did Nick and Laura sell?

Answer 33

20