Section 8: Market Structure and Perfect Competition
Question 1
1. For each of the following, is the business a price-taking producer? Explain your answers.
a. A cappuccino café in a university town where there are dozens of very similar cappuccino
cafés
b. The makers of Pepsi
c. One of many sellers of zucchini at a local farmers’ market
Solution 1
Question 2
2. For each of the following, is the industry perfectly competitive? Referring to market share,
standardization of the product, and/or free entry and exit, explain your answers.
a. Aspirin
b. Alicia Keys concerts
c. SUVs
Solution 2
Question 3
3. Bob produces Blu-ray movies for sale, which requires a building and a machine that copies
the original movie onto a Blu-ray. Bob rents a building for $30,000 per month and rents a
machine for $20,000 a month. Those are his fixed costs. His variable cost per month is given
in the accompanying table.
Quantity of Blu-rays
VC
0
$0
1,000
5,000
2,000
8,000
3,000
9,000
4,000
14,000
5,000
20,000
6,000
33,000
7,000
49,000
8,000
72,000
9,000
99,000
10,000
150,000
a. Calculate Bob’s average variable cost, average total cost, and marginal cost for each
quantity of output.
b. There is free entry into the industry, and anyone who enters will face the same costs as
Bob. Suppose that currently the price of a Blu-ray is $25. What will Bob’s profit be? Is
this a long-run equilibrium? If not, what will the price of Blu-ray movies be in the long
run?
Solution 3
Question 4
4. Consider Bob’s Blu-ray company described in Problem 3. Assume that Blu-ray production is
a perfectly competitive industry. For each of the following questions, explain your answers.
a. What is Bob’s break-even price? What is his shut-down price?
b. Suppose the price of a Blu-ray is $2. What should Bob do in the short run?
c. Suppose the price of a Blu-ray is $7. What is the profit-maximizing quantity of Blu-rays
that Bob should produce? What will his total profit be? Will he produce or shut down in
the short run? Will he stay in the industry or exit in the long run?
d. Suppose instead that the price of Blu-rays is $20. Now what is the profit-maximizing
quantity of Blu-rays that Bob should produce? What will his total profit be now? Will he
produce or shut down in the short run? Will he stay in the industry or exit in the long run?
Solution 4
Question 5
5. a. A profit-maximizing business incurs an economic loss of $10,000 per year. Its fixed cost is
$15,000 per year. Should it produce or shut down in the short run? Should it stay in the
industry or exit in the long run?
b. Suppose instead that this business has a fixed cost of $6,000 per year. Should it produce or
shut down in the short run? Should it stay in the industry or exit in the long run?
Solution 5
Question 6
6. The first sushi restaurant opens in town. Initially people are very cautious about eating tiny
portions of raw fish, as this is a town where large portions of grilled meat have always been
popular. Soon, however, an influential health report warns consumers against grilled meat
and suggests that they increase their consumption of fish, especially raw fish. The sushi
restaurant becomes very popular and its profit increases.
a. What will happen to the short-run profit of the sushi restaurant? What will happen to the
number of sushi restaurants in town in the long run? Will the first sushi restaurant be able
to sustain its short-run profit over the long run? Explain your answers.
b. Local steakhouses suffer from the popularity of sushi and start incurring losses. What will
happen to the number of steakhouses in town in the long run? Explain your answer.
Solution 6
Question 7
7. A perfectly competitive firm has the following short-run total cost:
Quantity
TC
0
$5
1
10
2
13
3
18
4
25
5
34
6
45
Market demand for the firm’s product is given by the following market demand schedule:
Price
$12
10
8
6
4
a. Calculate this firm’s marginal cost and, for all output levels except zero, the firm’s average
variable cost and average total cost.
b. There are 100 firms in this industry that all have costs identical to those of this firm. Draw
the short-run industry supply curve. In the same diagram, draw the market demand curve.
c. What is the market price, and how much profit will each firm make?
Solution 7
Question 8
8. A new vaccine against a deadly disease has just been discovered. Presently, 55 people die
from the disease each year. The new vaccine will save lives, but it is not completely safe.
Some recipients of the shots will die from adverse reactions. The projected effects of the
inoculation are given in the accompanying table:
a. What are the interpretations of “marginal benefit” and “marginal cost” here? Calculate
marginal benefit and marginal cost per each 10% increase in the rate of inoculation. Write
your answers in the table.
b. What proportion of the population should optimally be inoculated?
c. What is the interpretation of “profit” here? Calculate the profit for all levels of inoculation.
Solution 8
Question 9
9. Evaluate each of the following statements. If a statement is true, explain why; if it is false,
identify the mistake and try to correct it.
a. A profit-maximizing firm in a perfectly competitive industry should select the output level
at which the difference between the market price and marginal cost is greatest.
b. An increase in fixed cost lowers the profit-maximizing quantity of output produced in the
short run.
Solution 9
Question 10
10. The production of agricultural products like wheat is one of the few examples of a perfectly
competitive industry. In this question, we analyze results from a study released by the U.S.
Department of Agriculture about wheat production in the United States in 2016.
a. The average variable cost per acre planted with wheat was $115 per acre. Assuming a
yield of 44 bushels per acre, calculate the average variable cost per bushel of wheat.
b. The average price of wheat received by a farmer in 2016 was $4.89 per bushel. Do you
think the average farm would have exited the industry in the short run? Explain.
c. With a yield of 44 bushels of wheat per acre, the average total cost per farm was $7.71 per
bushel. The harvested acreage for wheat in the United States decreased from 48.8 million
acres in 2013 to 43.9 million acres in 2016. Using the information on prices and costs here
and in parts a and b, explain why this might have happened.
d. Using the above information, what do you think will happen to wheat production and
prices after 2016?
Solution 10
Question 11
WORK IT OUT Interactive step-by-step help with solving this problem can be found
online.
11. Kate’s Katering provides catered meals, and the catered meals industry is perfectly
competitive. Kate’s machinery costs $100 per day and is the only fixed input. Her variable
cost consists of the wages paid to the cooks and the food ingredients. The variable cost per
day associated with each level of output is given in the accompanying table.
Quantity of meals
VC
0
$0
10
200
20
300
30
480
40
700
50
1,000
a. Calculate the total cost, the average variable cost, the average total cost, and the marginal
cost for each quantity of output.
b. What is the break-even price and quantity? What is the shut-down price and quantity?
c. Suppose that the price at which Kate can sell catered meals is $21 per meal. In the short
run, will Kate earn a profit? In the short run, should she produce or shut down?
d. Suppose that the price at which Kate can sell catered meals is $17 per meal. In the short
run, will Kate earn a profit? In the short run, should she produce or shut down?
e. Suppose that the price at which Kate can sell catered meals is $13 per meal. In the short
run, will Kate earn a profit? In the short run, should she produce or shut down?
Solution 11