Microeconomics: Theory and Applications with Calculus, 3e (Perloff)
Chapter 8 Competitive Firms and Markets
8.1 Perfect Competition
1) Economists define a market to be competitive when the firms
A) spend large amounts of money on advertising to lure customers away from the competition.
B) watch each other’s behavior closely.
C) are price takers.
D) All of the above.
2) The residual demand curve is
A) the market demand minus the supply of other firms.
B) the remaining demand after the market clears.
C) the market demand minus the supply of one firm.
D) the long-run demand for a market.
3) As the number of firms in an industry increases, the residual demand curve becomes
A) more elastic.
B) less elastic.
C) larger.
D) vertical.
4) There are 10 identical internet service providers (ISPs) in a city serving a market demand with an
elasticity of -1.5. The elasticity of supply for each firm is 3.0. The elasticity of demand faced by an
individual ISP provider is
A) -42.
B) -15.
C) -1.5.
D) –27.
5) A market’s structure is described by
A) the number of firms in the market.
B) the ease with which firms can enter and exit the market.
C) the ability of firms to differentiate their product.
D) All of the above.
6) Firms that exhibit price-taking behavior
A) wait for other firms to set price, take it as given, and charge a higher price.
B) have outputs that are too small to influence market price and thus take it as given.
C) take pricing behavior in their own hands.
D) are independently capable of setting price.
7) If consumers view the output of any firm in a market to be identical to the output of any other firm in
the market, the demand curve for the output of any given firm
A) will be identical to the market demand curve.
B) will be horizontal.
C) will be vertical.
D) cannot be determined from the information given.
8) A horizontal demand curve for a firm implies that
A) the firm is a monopoly.
B) the market the firm is operating in is not competitive.
C) the firm is selling in a competitive market.
D) the products of that firm are very different from other firms’ products.
9) In the absence of any government regulation on price, if a firm has no power to set price on its own,
one can safely conclude
A) the demand curve for the firm’s product is horizontal.
B) there aren’t many firms in the industry.
C) the market is in long-run equilibrium.
D) the firms in this industry are not profitable.
10) In a perfectly competitive market,
A) firms can freely enter and exit.
B) firms sell a differentiated product.
C) transaction costs are high.
D) All of the above.
11) If all conditions for a perfectly competitive market are met,
A) firms face sunk cost when entering the market.
B) firms demand curves are horizontal.
C) the market demand curve is horizontal.
D) the firms’ demand curves are downward-sloping.
12) In a competitive market, if buyers did not know all the prices charged by the many firms,
A) all firms still face horizontal demand curves.
B) firms sell a differentiated product.
C) demand curves can be downward sloping for some or all firms.
D) the number of firms will most likely decrease.
13) Many car owners and car dealers describe their different cars for sale in the local newspapers and list
their asking price. Many people shopping for a used car consider the different choices listed in the paper.
The market for used cars could be described as
A) relatively competitive.
B) perfectly competitive.
C) non-competitive.
D) having high transaction costs.
14) Many car owners and car dealers describe their different cars for sale in the local newspapers and list
their asking price. Many people shopping for a used car consider the different choices listed in the paper.
The absence of which condition prohibits this market from being described as perfectly competitive?
A) Buyers and sellers know the prices.
B) Firms freely enter and exit.
C) Transaction costs are low.
D) Consumers believe all firms sell identical products.
15) A special license is required to operate a taxi in many cities. The number of licenses is restricted. More
drivers want licenses than are issued. This describes a non-perfectly competitive market because
A) taxi services are very different.
B) firms cannot freely enter and exit the market.
C) transaction costs are high.
D) the government generates revenue from the licenses.
16) If a firm operates in a perfectly competitive market, then it will most likely
A) advertise its product on television.
B) settle for whatever price is offered.
C) have a difficult time obtaining information about the market price.
D) have an easy time keeping other firms out of the market.
17) If a firm operates in a perfectly competitive market, then
A) all firms will advertise.
B) no firms will advertise.
C) the market leader will advertise.
D) new firms will advertise.
18) The “Got Milk?” advertising campaign is a good example of
A) advertising in a competitive market.
B) how advertising in a competitive market does not pay off for a single firm.
C) interest groups financed by the industry advertise for the whole industry.
D) All of the above.
19) The perfectly competitive model makes a lot of fairly unrealistic assumptions. Why do economics text
books still talk a lot about this model?
A) Many markets are close to being perfectly competitive.
B) It is an important model to use as a benchmark to compare other markets structures to.
C) Perfectly competitive markets maximize societal welfare.
D) All of the above.
20) If a firm happened to be the only seller of a particular product, it might behave as a price taker as long
as
A) buyers have full information about the firm’s price.
B) the transaction costs of doing business with this firm are low.
C) there are many buyers.
D) there is free entry and exit.
21) The demand curve an individual competitive firm faces is known as its
A) excess demand curve.
B) market demand curve.
C) residual demand curve.
D) leftover demand curve.
22) Gift shops in a small town sell identical mugs to tourists. However, tourists don’t have enough time to
check out the prices one by one and don’t have brochures listing prices of mugs. We can conclude
A) the market for mugs is perfectly competitive.
B) buyers have full information.
C) sellers are price takers.
D) the market is not perfectly competitive.
For the following, please answer “True” or “False” and explain why.
23) A market is perfectly competitive even if firms have the ability to set their own price as long as the
price difference reflects differences in the product.
24) If transaction costs are high, then it is more likely a firm’s demand curve is downward sloping.
25) Explain why individual firms in competitive markets face more elastic demand curves than the
market as a whole.
8.2 Profit Maximization
1) If a firm makes zero economic profit, then the firm
A) has no incentive to stay in the industry.
B) is better of exiting the industry.
C) is indifferent between staying and exiting the industry.
D) will shut down.
2) If a firm makes zero economic profit, then the firm
A) has total revenues greater than its economic costs.
B) must shut down.
C) can be earning positive business profit.
D) must have no fixed costs.
3) A small business owner earns $50,000 in revenue annually. The explicit annual costs equal $30,000. The
owner could work for someone else and earn $25,000 annually. The owner’s business profit is ________
and the economic profit is ________.
A) $20,000, $5,000
B) $20,000, -$5,000
C) $25,000, -$5,000
D) $45,000, -$5,000
4) A small business owner earns $60,000 in revenue annually. The explicit annual costs equal $40,000. The
owner could work for someone else and earn $25,000 annually. The owner’s business profit is ________
and the economic profit is ________.
A) $20,000, $5,000
B) $20,000, -$5,000
C) $25,000, -$5,000
D) $45,000, -$5,000
5) A lawyer running his own business earns $18,000 in revenue monthly. He pays $8,000 as explicit costs
including staff salary and utilities. He owns the office space so no rent is paid.. The lawyer could work for
other legal firms and earn $10,000 per month. His business profit is ________ and his economic profit is
________.
A) $10,000, $10,000
B) $28,000, $10,000
C) $10,000, $0
D) $8,000, $0
6) If marginal revenue equals marginal cost, the firm is maximizing profits as long as
A) the resulting profits are positive.
B) marginal cost exceeds marginal revenue for greater levels of output.
C) the average cost curve lies above the demand curve.
D) All of the above are required.
7) If a firm is operating at an output level where losses are minimized, the firm
A) has no incentive to stay in the industry.
B) is better of exiting the industry.
C) is maximizing profits.
D) will shut down.
8) The above figure shows the cost curves for a competitive firm. If the firm is to earn economic profit,
price must exceed
A) $0.
B) $5.
C) $10.
D) $11.
9) The above figure shows the cost curves for a competitive firm. The firm will incur economic losses if
the price is less than
A) $0.
B) $5.
C) $10.
D) $11.
10) The above figure shows the cost curves for a competitive firm. If the market price is $15 per unit, the
firm will earn profits of
A) $0.
B) $4.
C) $40.
D) $160.
11) If a competitive firm maximizes short-run profits by producing some quantity of output, which of the
following must be true at that level of output?
A) p = MC.
B) MR = MC.
C) p ≥ AVC.
D) All of the above.
12) If a competitive firm maximizes short-run profits by producing some quantity of output, which of the
following must be true at that level of output?
A) p > MC.
B) MR > MC.
C) p ≥ AVC.
D) All of the above.
13) If a profit-maximizing firm finds that, at its current level of production, MR > MC, it will
A) earn greater profits than if MR = MC.
B) increase output.
C) decrease output.
D) shut down.
14) If a profit-maximizing firm finds that, at its current level of production, MR < MC, it will
A) decrease output.
B) increase output.
C) shut down.
D) operate at a loss.
15) Suppose the fixed cost of Christmas trees business is $7,000 and sunk. The variable cost for each tree is
$20. According to the forecast, the market price for Christmas trees is $25 each and the owner could sell
1000 trees at most each year. The owner
A) should shut down the business.
B) should keep operating.
C) should sell less.
D) None of the above.
16) Suppose the estimated fixed cost of Christmas trees business is $7,000 and not sunk. The estimated
variable cost for each tree is $20. According to the forecast, the market price for Christmas trees is $25
each and the owner could sell 1000 trees at most each year. In the long run, the owner
A) should shut down.
B) should keep operating.
C) should sell less.
D) None of the above.
17) Suppose the Christmas trees market is perfectly competitive. A business owner is currently suffering
from a loss of $1,000, the cost of producing and selling an additional Christmas tree is $20, and the
current market price is $25. The owner
A) should sell more trees.
B) should shut down his business now.
C) should advertise in the market.
D) is already minimizing his loss.
18) Suppose the Christmas trees market is perfectly competitive. An owner is currently earning a profit of
$1,000, the cost of producing and selling an additional Christmas tree is $25, the current market price is
$20. The owner
A) should sell more trees.
B) should not sell more trees.
C) should advertise in the market to promote his sales.
D) is not maximizing his profits.
For the following, please answer “True” or “False” and explain why.
19) Even though fixed costs do not affect the output decision, an increase in fixed costs results in a wider
range of prices for which the firm operates at a loss.
20) If a firm sets marginal revenue equal to marginal cost, it will make an economic profit.
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21) If a firm doesn’t make an economic profit, it will shut down.
22) Suppose there are 20 competitive firms in a market. The supply curve of each firm is q = 2p. The
market demand is Q = 200 – 2p. What is the residual demand curve facing a typical firm?
23) Explain why shutting down and going out–of-business are different concepts.
24) Suppose a firm has the following total cost function: TC = 100 + 4q2. What is the minimum price
necessary for the firm to earn profit? Below what price will the firm shut down in the short run?
25) The above figure shows the cost curves for a typical firm in a competitive market. Note that if p = 10,
then MC = p at both q = 5 and q = 60. Can they both yield maximum profit? Explain.
26) Lelu runs a firm that sells multipasses to intergalactic cruises. Her short-run cost function is given by
C(q) = q2 + 25q + 144
a. If the market price is $75/pass, how many units will Lelu produce?
b. At what price will Lelu earn zero profits?
c. If the price is below the level you found in b., will Lelu shut down? If so, explain. If not, below what
price will she shut down?
27) A firm that only employs labor (L) has the following production function:
f(L) = 20L – L2
Let the price of output be normalized to one and the price of labor (relative to output price) is w.
a. Write out the profit function for this firm as a function of labor, L.
b. What is the necessary first-order condition for the firm to maximize profit when L > 0?
c. Compute the profit maximizing amount of labor as a function of the wage. What is the effect of an
increase in wage on the firm’s optimal employment level? Use calculus to solve this.
8.3 Competition in the Short Run
1) A firm should always shut down if its revenue is
A) declining.
B) less than its average fixed costs.
C) less than its total costs.
D) less than its avoidable costs.
2) If a competitive firm finds that it maximizes short-run profits by shutting down, which of the following
must be true?
A) p < AVC for all levels of output.
B) p < AVC only for the level of output at which p = MC.
C) p < AVC only if the firm has no fixed costs.
D) The firm will earn zero profit.
3) The above figure shows the cost curves for a competitive firm. If the firm is to operate in the short run,
price must exceed
A) $0.
B) $5.
C) $10.
D) $11.
4) The above figure shows the cost curves for a competitive firm. If the profit–maximizing level of output
is 40 price is equal to
A) $0.
B) $15.
C) $10.
D) $11.
5) A firm will shut down in the short run if
A) total fixed costs are too high.
B) total revenue from operating would not cover all costs.
C) total revenue from operating would not cover variable costs.
D) total revenue from operating would not cover fixed costs.
6) The competitive firm’s supply curve is equal to
A) its marginal cost curve.
B) the portion of its marginal cost curve that lies above AC.
C) the portion of its marginal cost curve that lies above AVC.
D) the portion of its marginal cost curve that lies above AFC.
7) If a firm is a price taker, then its marginal revenue will always equal
A) price.
B) total cost.
C) zero.
D) one.
8) An increase in the cost of an input will result in
A) a leftward shift in the firm’s supply curve.
B) an upward shift of the firm’s marginal cost curve.
C) a leftward shift of the market supply curve.
D) All of the above.
9) When the production of a good involves several inputs, an increase in the cost of one input will usually
cause total costs to
A) rise more than in proportion.
B) rise less than in proportion.
C) remain unchanged.
D) rise by the exact amount of the input price increase.
10) When the production of a good involves several inputs and inputs are used in fixed proportions, an
increase in the cost of one input will usually cause total costs to
A) rise more than in proportion.
B) rise less than in proportion.
C) remain unchanged.
D) rise by the exact amount of the input price increase.