Practice Questions Tutorial 8

Question 1

A firm operating in a perfectly competitive industry faces the cost curves shown in
Figure 1. P0 is the current market price..

What is the profit made by the firm at this level of price and output

Answer 1

Profit = excess of AR over AC multiplied by output

PHOTO 26/9

Question 2

A firm operating in a perfectly competitive industry faces the cost curves shown in
Figure 1. P0 is the current market price.

If you were told that this industry was in equilibrium, would you judge it as a short-run or
a long-run equilibrium? Why?

Answer 2

Short run. Because perfectly competitive firms make only normal profits in the
long run.

PHOTO 26/9

Question 3

Q2 WORKINGS

(a) Should Jane enter into the Turnip Chip industry? Why or why not?
(b) What will be the long-run competitive equilibrium price for Turnip Chips?
(c) Could Jane earn a profit at this long-run price?

Answer 3

2 PHOTOS 26/9

A. Yes she should. At a market price of $8, each supplier produce five bags of chips, has revenue of $40, fixed costs of $10, and variable costs of $22, leading
to an economic profit of $8.

B. PHOTO 26/9

c. ) She won’t be making an economic profit but can still make an accounting profit.

Question 4

What is meant by the term ‘excess capacity’ as it relates to monopolistically competitive
firms? Use a graph to demonstrate why a profit-maximising monopolistically competitive
firm must operate at excess capacity. Explain why a perfectly competitive firm is not subject
to the same constraint.

Answer 4

In the long run, monopolistically competitive firms produce a level of output lower
than the efficient scale and are therefore said to have excess capacity. Use the
monopolistic competition diagram from the lecture. It shows that for monopolistically
competitive firms, profit maximising output level is less than the efficient scale.
Perfectly competitive firms are not subject to this same constraint, as they do not
face downward-sloping demand.