Chapter 10/The Firm and the Industry under Perfect Competition
CHAPTER 10
THE FIRM AND THE INDUSTRY UNDER
PERFECT COMPETITION
TEST YOURSELF
1.Under what circumstances might you expect the demand curve of the firm to be
a. Vertical?
b. Horizontal?
c. Negatively sloping?
d. Positively sloping?
(a) A demand curve might be vertical for a good that is absolutely necessary
to the continuance of life, or for a good which is so cheap and which has so few close
substitutes that a rise in price would barely be noticed by the consumer.
2. Explain why P = MC in the short-run equilibrium of the perfectly competitive firm,
whereas in long-run equilibrium P = MC = AC.
In the short run, a profit-maximizing firm sets output at a point where MR = MC.
3. Explain why it is not sensible to close a business firm if it earns zero economic profits.
If a firm is earning zero economic profit, the owner’s invested capital is earning
4. If the firm’s lowest average cost is $52 and the corresponding average variable cost is
$26, what does it pay a perfectly competitive firm to do if
a. The market price is $51?
Chapter 10/The Firm and the Industry under Perfect Competition
b. The price is $36?
c. The price is $12?
(a) If the market price is $51, the firm should reduce output to produce at the
point where MC = $51. The firm will lose money, but the price is more than AVC,
and therefore it loses less money than if it quit altogether, and had to pay its fixed
5. If the market price in a competitive industry were above its equilibrium level, what
would you expect to happen?
If the market price is above equilibrium, profits will attract new firms into the
DISCUSSION QUESTIONS
1. Explain why a perfectly competitive firm does not expand its sales without limit if its
horizontal demand curve indicates that it can sell as much as it desires at the current
market price.
A profit-maximizing firm produces output at the point where marginal revenue
equals marginal cost. A perfectly competitive firm does not face the phenomenon of
2. Explain why a demand curve is also a curve of average revenue. Recalling that when
an average revenue curve is neither rising nor falling, marginal revenue must equal
average revenue, explain why it is always true that P = MR = AR for the perfectly
competitive firm.
The demand curve shows the price, P, at which different levels of output can be
sold. But P = PQ/Q, (where Q is output), and PQ is equal to total revenue, TR. Therefore,
P = TR/Q = AR, or average revenue. So the demand curve is a curve of average revenue.
3. Regarding the four attributes of perfect competition (many small firms, freedom of
entry, standardized product, and perfect information):
a. Which is primarily responsible for the fact that the demand curve of a perfectly
competitive firm is horizontal?
b. Which is primarily responsible for the firm’s zero economic profits in long-run
Chapter 10/The Firm and the Industry under Perfect Competition
equilibrium?
(a) The fact that all firms sell a standardized product is primarily responsible
in that customers have no reason to stay with one supplier if its price is higher than
4. We indicated in this chapter that the MC curve cuts the AVC (average variable cost)
curve at the minimum point of the latter. Explain why this must be so. (Hint: Because
marginal costs are, by definition, entirely composed of variable costs, the MC curve
can be considered the curve of marginal variable costs. Apply the general relationships
between marginals and averages explained in the appendix to Chapter 8.)
Total costs are equal to total fixed costs plus total variable costs. Marginal costs
are equal to the change in fixed costs plus the change in variable costs. However, since
5. (More difficult) In this chapter we stated that the firm’s MC curve goes through the
lowest point of its AC curve and also through the lowest point of its AVC curve.
Because the AVC curve lies below the AC curve, how can both of these statements be
true? Why are they true? (Hint: See Figure 4.)
The MC curve consists only of variable costs, and so it goes through the low point
of the AVC curve. It also goes through the low point of the AC curve. The AC curve lies