252 ❖ Chapter 14/Firms in Competitive Markets
E. Why the Long-Run Supply Curve Might Slope Upward
1. Because we assumed that all potential entrants faced the same costs as existing firms,
average total cost of each firm was unaffected by the entry of new firms into the market.
2. In this situation, the long-run supply of the market will be a horizontal line at minimum
average total cost.
4. In this situation, the long-run supply curve of the market will be upward sloping.
Figure 8
No matter what the shape of the long-run supply curve, an increase in demand will
Chapter 14/Firms in Competitive Markets ❖ 253
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
2. A profit-maximizing competitive firm sets price equal to its marginal cost. If price were above
marginal cost, the firm could increase profits by increasing output, while if price were below
marginal cost, the firm could increase profits by decreasing output.
3. In the long run, with free entry and exit, the price in the market is equal to both a firm’s
marginal cost and its average total cost, as Figure 1 shows. The firm chooses its quantity so
that marginal cost equals price; doing so ensures that the firm is maximizing its profit. In the
long run, entry into and exit from the market drive the price of the good to the minimum
point on the average-total-cost curve.
Figure 1
Questions for Review
1. A competitive firm is a firm in a market in which: (1) there are many buyers and many sellers
2. A firm’s total revenue equals its price multiplied by the quantity of units it sells. Profit is the
254 ❖ Chapter 14/Firms in Competitive Markets
3. Figure 2 shows the cost curves for a typical firm. For a given price (such as
P
*), the level of
output that maximizes profit is the output where marginal cost equals price (
Q
*), as long as
Figure 2
4. A firm will shut down temporarily if the revenue it would get from producing is lower than the
variable costs of production. This occurs if price is less than average variable cost.
6. A firm’s price equals marginal cost in both the short run and the long run. In both the short
run and the long run, price equals marginal revenue. The firm should increase output as long
7. The firm’s price must equal the minimum of average total cost only in the long run. In the
short run, price may be greater than average total cost (in which case the firm is earning a
profit), price may be less than average total cost (in which case the firm is incurring a loss),
Chapter 14/Firms in Competitive Markets ❖ 255
8. Market supply curves are typically more elastic in the long run than in the short run. In a
Problems and Applications
1. a. As shown in Figure 3, the typical firm’s initial marginal-cost curve is
MC
1 and its average-
total-cost curve is
ATC
1. In the initial equilibrium, the market supply curve,
S
1, intersects
b. The increase in the price of oil shifts the typical firm’s cost curves up to
MC
2 and
ATC
2,
and shifts the market supply curve up to
S
2. The equilibrium price rises from
P
1 to
P
2, but
the price does not increase by as much as the increase in marginal cost for the firm. As a
result, price is less than average total cost for the firm, so profits are negative.
2. Once you have ordered the dinner, its cost is sunk, so it does not represent an opportunity
cost. As a result, the cost of the dinner should not influence your decision about whether to
finish it or not.
256 ❖ Chapter 14/Firms in Competitive Markets
3. Because Bob’s average total cost is $280/10 = $28, which is greater than the price, he will
4. Here is the table showing costs, revenues, and profits:
Quantity
Total
Cost
Marginal
Cost
Total
Revenue
Marginal
Revenue
Profit
0
$8
—
$0
—
$-8
1
8
$8
2
1
8
3
1
8
4
2
8
5
6
8
6
8
8
7
8
b. Marginal revenue and marginal cost are graphed in Figure 4. The curves cross at a
quantity between five and six units, yielding the same answer as in Part (a).
Chapter 14/Firms in Competitive Markets ❖ 257
5. a. Costs are shown in the following table:
Q
TVC
AFC
AVC
MC
0
$0
—-
—-
—-
1
50
$100
$50
50
b. If the price is $50, the firm will minimize its loss by producing 4 units. This would give
the firm a loss of $40. If the firm shuts down, it will earn a loss equal to its fixed cost
($100).
6. a. Figure 5 shows the typical firm in the industry, with average total cost
ATC
1, marginal
cost
MC
1, and price
P
1.
b. The new process reduces Hi-Tech’s marginal cost to
MC
2 and its average total cost to
ATC
2, but the price remains at
P
1 because other firms cannot use the new process. Thus
Hi-Tech earns positive profits.
Figure 5
7. Since the firm operates in a perfectly competitive market, its price is equal to its marginal
revenue of $10. This means that average revenue is also $10 and 50 units were sold.
2
100
70
20
3
100
90
20
4
100
140
35
50
5
60
258 ❖ Chapter 14/Firms in Competitive Markets
8. a. Profit is equal to (
P
–
ATC
) ×
Q
. Price is equal to
AR
. Therefore, profit is ($10 – $8) ×
100 = $200.
b. For firms in perfect competition, marginal revenue and average revenue are equal. Since
9. a. If firms are currently incurring losses, price must be less than average total cost.
However, because firms in the industry are currently producing output, price must be
greater than average variable cost. If firms are maximizing profits, price must be equal to
marginal cost.
b. The present situation is depicted in Figure 6. The firm is currently producing
q
1 units of
output at a price of
P
1.
c. Figure 6 also shows how the market will adjust in the long run. Because firms are
incurring losses, there will be exit in this industry. This means that the market supply
Chapter 14/Firms in Competitive Markets ❖ 259
10. a. The table below shows
TC
and
ATC
for a typical firm:
Q
TC
ATC
1
11
11
2
15
7.5
3
21
7
4
29
7.25
5
39
7.8
6
51
8.5
b. At a price of $11, quantity demanded is 200. Since marginal revenue is $11, each firm
will choose to produce 5 pies. Therefore, there will be 40 firms (= 200/5). Each producer
will earn total revenue of $55 ($11 5), total cost is $39, so profit is $16.
11. a. Figure 7 illustrates the situation in the U.S. textile market. With no international trade,
the market is in long-run equilibrium. Supply intersects demand at quantity
Q
1 and price
$30, with a typical firm producing output
q
1.
Figure 7
b. The effect of imports at $25 is that the market supply curve follows the old supply curve
up to a price of $25, then becomes horizontal at that price. As a result, demand exceeds
domestic supply, so the country imports textiles from other countries. The typical
260 ❖ Chapter 14/Firms in Competitive Markets
12. a. The firms’ variable cost (
VC
), total cost (
TC
), marginal cost (
MC
), and average total cost
(
ATC
) are shown in the table below:
Quantity
VC
TC
MC
ATC
1
1
17
1
17
b. If the price is $10, each firm will produce 5 units, so there will be 5 100 = 500 units
supplied in the market.
13. a. Figure 9 shows the current equilibrium in the market for pretzels. The supply curve,
S
1,
intersects the demand curve at price
P
1. Each stand produces quantity
q
1 of pretzels, so
the total number of pretzels produced is 1,000 ×
q
1. Stands earn zero profit, because
price is equal to average total cost.
2
4
21
3
3
9
26
5
4
16
32
7
8
5
25
41
9
6
36
52
11
Chapter 14/Firms in Competitive Markets ❖ 261
Figure 9
b. If the city government restricts the number of pretzel stands to 800, the market supply
curve shifts to
S
2. The market price rises to
P
2, and individual firms produce output
q
2.
Market output is now 800 ×
q
2. Now the price exceeds average total cost, so each firm is
making a positive profit. Without restrictions on the market, this would induce other firms
to enter the market, but they cannot because the government has limited the number of
licenses.