Chapter 24 Perfect Competition Exam V2 MULTIPLE CHOICE.

Choose the one alternative that best completes the statement or answers the question. 1) A firm in a perfectly competitive industry is a A) price taker. B) price searcher. C) price controller. D) price competitor.

2) Under perfect competition, a firm that set price slightly above the market price would A) make lower profits than the other firms, but the amount would depend on the elasticity of demand. B) be forced to lower price again because the firm would not be able to stay in business with the reduced revenues. C) lose all of its customers. D) earn higher profits as long as the other firms continued to charge the market price. 3) A) B) C) D) A price taker is someone who takes the highest price possible. cannot influence the price. searches for the best price, and then takes the highest profits possible. buys inputs for firms.

4) Based on the assumptions of the perfectly competitive model, consumers will base their decisions on which firm to purchase a good from on the basis of A) quality. B) customer service. C) reputation. D) price. 5) A) B) C) D) Which of the following is not a characteristic of perfect competition? There are a large number of buyers and sellers The firms in an industry produce heterogeneous goods Any firm can enter or leave the industry without serious impediments Both buyers and sellers have equally good information

6) In the model of perfect competition one price prevails for any specific good. All of the following assumptions are needed to get this result except A) there are a large number of buyers and sellers. B) the product sold by the firms in the industry must be homogeneous. C) any firm can enter or leave the industry without serious impediments. D) both buyers and sellers have equally good information. 7) A perfectly competitive producer faces a demand curve that is A) downward sloping. B) upward sloping. C) horizontal. D) vertical.

8) Which of the following statements is correct? A) The demand curve of the perfectly competitive industry is horizontal as are the demand curves facing the individual firms. B) The market demand curve of perfect competition is horizontal because the individual consumers are buying a homogeneous product. C) The market demand curve of the perfectly competitive industry is downward sloping while the demand curve facing an individual firm is horizontal. D) The market demand curve of the perfectly competitive industry is downward sloping, so the demand curves of the individual firms are also downward sloping. 9) A) B) C) D) The demand curve of a perfectly competitive firm is perfectly elastic. perfectly inelastic. elastic at high prices and inelastic at low prices. identical to the elasticity of demand on the market demand curve.

10) We assume that firms, when they are deciding the best rate of output at which to produce, A) try to get the highest price possible. B) want to maximize sales. C) want to minimize costs. D) want to maximize profits. 11) A) B) C) D) 12) A) B) C) D)
13) A) B) C) D)

For a perfect competitor, price equals marginal revenue only. average revenue only. both average revenue and marginal revenue. neither marginal revenue not average revenue. Under perfect competition, the firm must decide the best price to charge for its product. the best rate of output it should produce. the optimal price-output combination. the optimal level of quality and the packaging that will maximize profits.
Marginal revenue equals total revenue divided by output. price times quantity, divided by average revenue. total revenue divided by average revenue. the change in total revenue from selling one more unit.

14) For a perfect competitor, marginal revenue equals A) the slope of the demand curve. B) average revenue divided by price. C) price divided by average revenue. D) price. 15) The perfectly competitive firm maximizes profits when A) it produces and sells the quantity at which the difference between marginal revenue and marginal cost is the greatest.

B) it produces and sells the quantity at which marginal revenue and marginal cost are equal. C) it produces and sells the quantity at which the difference between average revenue and average cost is the greatest. D) it produces and sells the quantity at which the difference between price and average cost is the greatest. 16) If marginal revenue is less than marginal cost, the firm should A) raise price. B) raise marginal revenue. C) increase its rate of output. D) decrease its rate of output.

17) Refer to the table above. If the price is $10, the perfectly competitor should produce A) between 103 and 104 units. B) 107 units. C) 109 units. D) 110 units. 18) Refer to the table above. If price is initially $4 and then increases to $8, the perfect competitor will A) double output. B) increase output by 10 units. C) increase output by 8 units. D) increase output by 4 units. 19) A perfectly competitive This implies that it is A) making the most profits B) making the most profits positive. C) making the most profits zero. D) making the most profits total cost. 20) firm is maximizing profits in the short run. possible and that profits are positive. possible and that profits are either zero or possible, which can be positive, negative, or possible, which is where price equals average

The difference between price and average total cost is A) total profits. B) marginal profits. C) average profit. D) an irrelevant quantity.

21) Refer to the figure above. If the price is $3.70, profits are A) zero B) $2112.50 C) $3250.00 D) $5362.50 22) Refer to the figure above. What are the firms profits if the price is $2.00? A) Zero B) -$2500 C) -$2625 D) -$3000 23) Refer to the figure above. If the firm is making zero profits, then it is selling A) 2500 units at a price of $2.00 B) 3250 units at a price of $3.70 C) 3000 units at a price of $3.00 D) 4800 units at a price of $2.80
24) Refer to the figure above. What are the maximum losses the firm would make in the short run? A) Zero B) $2500 C) $2625 D) Cant tell from this figure. More information is needed. 25) Refer to the figure above. The short-run shutdown price is A) $3.00. B) $2.80. C) $2.00. D) $1.50. A firm will shut down in the short run when price is below average total costs at all possible rates of output. price is below average variable costs at all possible rates of output. price is below marginal cost at all possible rates of output. whenever it is making a loss. A perfect competitor should never make losses A) at all. B) greater than its variable costs.

26) A) B) C) D) 27)

C) 28)

greater than its total costs. D) greater than its fixed costs.

A firm that shuts down in the short run experiences losses equal to A) zero. B) total variable costs. C) total fixed costs. D) total costs.

29) Suppose a firm is producing in the short run but making it equal to its fixed costs minus $500. If its fixed costs increase by $1000, the firm should A) shut down because its fixed costs increased by more than $500. B) shut down, but it should have shut down even before the fixed costs increased. C) increase its rate of output in order to increase revenues and reduce its losses. D) not change its rate of output even though it is making a larger loss because it is still covering its variable costs. 30) A firm is currently producing at the rate of output that just covers its variable costs. If demand falls, the firm should A) lower both price and its rate of output. B) shut down. C) increase its rate of output to make up for the lower price. D) not change its rate of output because it is still covering its variable costs. 31) A) B) C) D) Accounting profits are the firms short-run break-even point are zero. positive. negative. indeterminate without more information.

32) The firm is making a 4 percent accounting rate of return in the short run. Then it is making an economic rate of return that is A) zero. B) positive, but less than 4 percent. C) negative. D) indeterminate without more information. 33) The owner of a perfectly competitive firm that is making economic losses in the short run A) should alter the rate of output in order to increase profitability. B) should cut his own salary in order to reach the break-even point. C) is actually losing more than he thinks because the opportunity cost of his time has not yet been considered. D) is making less than he would if he worked for someone else. 34) The shortrun supply curve of a perfect competitor is A) its average variable cost curve. B) its marginal revenue curve. C) its marginal cost curve. D) its marginal cost curve equal to or above the minimum point on its average variable cost curve.

35) A perfectly competitive firm is producing zero units of output in the short run. We know that price is A) zero. B) below the minimum point of its average variable costs. C) below the minimum point of its average total costs. D) between the minimum points of average total costs and average fixed costs. 36) The short-run industry supply curve is found by A) horizontally summing the marginal cost curves of all firms in the industry. B) horizontally summing the marginal costs curves that lie above the minimum point of the average total cost curve of all firms in the industry. C) adding up the quantities supplied at each price by each firm in the industry. D) adding up the quantities supplied at each price by each of the firms in the industry that are making a profit. 37) A) B) C) D) 38) A) B) C) D) The short-run industry supply curve slopes up because the firms eventually experience diseconomies of scale. the law of diminishing marginal returns applies in the short run. wages increase as the industry increases output. the higher price is needed to get more firms to enter the industry. Things that also things things that things that things that cause the shortrun supply curve to change are that affect demand. affect total costs. affect variable costs. affect the market but not the individual firm.

39) An increase in the productivity of labor causes A) quantity supplied by each firm in a competitive industry to increase. B) supply in a competitive industry to increase. C) the market price to increase in a competitive industry. D) the firms supply curve to shift but has no effect on the industry supply curve. 40) If the wage rate increases and firms in a perfectly competitive industry are hiring labor, then A) the firms will quit using labor. B) the quantity supplied in the industry will decrease. C) market supply will decrease. D) market price will decrease. 41) Under perfect competition, the demand curve facing the firm is determined by A) the intersection of the industry demand and supply curves. B) the tastes and preferences of consumers. C) utility maximizing behavior on the part of consumers. D) the willingness of the firm to supply the good. 42) The market demand curve in perfect competition is found by A) horizontally summing the demand curves of the individual firms in the industry. B) horizontally summing the demand curves of the individual consumers. C) utility maximizing behavior of the representative consumer.

D) the interaction of supply and demand at the individual firm and consumers levels. 43) In a competitive market, demand and supply intersect at a price of $8. From this we know that A) the average total cost of producing the good is $8. B) the average variable cost of producing the good is $8. C) the marginal cost of producing the good is $8. D) the firm is making a positive economic profit at a price of $8 or more. 44) A) B) C) D) In the long run, a perfect competitor can make positive profits but will not make losses. can make positive profits or losses. makes zero profits. produces at its shut-down point.

45) Signals are A) used by economic decision-makers to inform others about their plans. B) the method by which government planners inform economic decision makers about the types of decisions they should make. C) the method by which economic efficiency is achieved. D) compact ways of conveying to economic decision makers information needed to make economic decisions. 46) A) B) C) D) A true signal must convey information only. convey information and provide the inventive to act appropriately. convey information about what should be done and why it should be done. explain why something should be done only.

47) Profits and losses are true signals because they A) convey information about where to place resources. B) cannot be misinterpreted by entrepreneurs. C) convey information about where to place resources and reward people who act on the information. D) reward people who make profits with even more profits and punish those who make losses with even more losses. 48) Firms in a perfectly competitive industry are making economic losses. This is A) a signal to entrepreneurs that some of the firms in the industry should exit and the resources of these firms should move into production of other goods. B) a signal to entrepreneurs that additional resources should be brought into this industry in order to make it profitable. C) a signal that the entrepreneurs are doing a poor job and should become workers for someone else. D) a signal to government officials that a subsidy is needed for the firms in the industry. 49) Which of the following would tell us that resources are not flowing to their highest valued uses? A) Short-run profits B) Short-run losses

C) 50) A) B) C) D) 51) A) B) C) D)

Long-run profits

D) Some firms going out of business

Along an industrys long-run supply curve, profits are positive. profits are zero. entrepreneurs earn an aboveaverage rate of return. the number of firms is constant. If the long-run supply curve is upward sloping, we know that entrepreneurs are earning higher profits as output expands. some input prices are increasing as the industry expands. firms are getting larger as the industry output expands. the law of diminishing marginal returns has set in.

52) Suppose a perfectly competitive industry is in longrun equilibrium. If a decrease in demand leads to a lower long-run price, we know that A) this is a decreasingcost industry. B) this is an increasingcost industry. C) some firms will be losing money in the long run. D) after further adjustments, price will rise to its original level. 53) A) B) C) D) A perfectly elastic longrun supply curve indicates a decreasingcost industry. a constantcost industry. an increasingcost industry. that some input prices change as firms enter and exit the industry.

54) Refer to the figure above. Suppose the original equilibrium is at E and then demand increases to D1. We know that A) E1 is the new short-run equilibrium and that firms are making positive economic profits. B) new firms are not yet entering, but when they do they will face the same input prices as existing firms. C) the entry of new firms caused some input prices to increase. D) some of the firms are making economic profits while other firms are making zero economic profits.

55) A) B) C) D) 56) A) B) C) D) 57) is

Refer to the figure above. The industry in the figure is a(n) decreasingcost industry. constant-cost industry. increasingcost industry. industry that is not yet in long-run equilibrium. If a perfectly competitive industry is in longrun equilibrium, then price equals average cost. price is greater than average cost and equal to marginal cost. all firms earn the same accounting profits. marginal cost is less than average cost. The opportunity cost to society of producing one more unit of the good A) C) average cost. efficiency costing. B) marginal cost. D) the optimal cost.

58) When price equals marginal cost A) firms make zero profits. B) firms make positive profits. C) the industry is in long-run equilibrium. D) the marginal benefits of consuming an extra unit of the good exactly equals the marginal cost to society of producing the good. 59) The value of total output decreases when labor leaves one industry and goes to another and capital leaves the second industry and goes to the first. This indicates that A) the first situation was not efficient. B) the second situation is efficient. C) price is greater than marginal cost. D) it would be efficient to return to the first situation. 60) units A) B) C) D) Suppose the perfectly competitive equilibrium occurs such that too many of the good are produced. This is an example of marginal cost pricing. market failure. firms being unable to exit the industry. greedy business people behaving in an inappropriate manner.

61) With marginal cost pricing A) marginal benefits are usually less than marginal cost. B) all opportunity costs will be covered in the short- run. C) the price charged is equal to the opportunity cost to society of producing one more unit of the good. D) there can not be any short-run economic profit. 62) A) C) When MR < MC for a firm, the firm should reduce its level of output. B) stay at the same level of output. stop producing. D) increase output, unless P < AVC.

63)

Each firm in a perfectly competitive industry is A) producing a unique product. B) relatively large. C) a price taker. D) a price setter.

64) Which of the following is NOT a characteristic of a perfectly competitive industry? A) There are a large number of buyers and sellers. B) The firms in the industry produce a homogeneous product. C) Sellers have better information about the product than consumers. D) Any firm can enter or leave the industry without serious impediments. 65) The lemons problem is a situation in which A) consumers have more information than sellers about the quality of a product. B) sellers are able to coerce buyers into buying products they really dont want. C) consumers are only willing to pay the price of a lowquality product because they dont know the actual level of quality. D) sellers are unwilling to manufacture high quality items because people dont want high quality products. 66) A) B) C) D) The demand curve of a perfectly competitive industry is downward sloping. horizontal. vertical. indeterminate without more information.

67) The demand curve of a perfectly competitive firm is A) elastic at relatively high prices and inelastic at relatively low prices. B) perfectly elastic. C) perfectly inelastic. D) unitary elastic. 68) A firm in a perfectly finds A) the price at which total B) the quantity at which C) the quantity at which D) the quantity at which 69) competitive market maximizes profits when it revenue minus total revenue total revenue total revenue total cost is the greatest. minus total cost is the greatest. equals total cost. is maximized.

For a firm in a perfectly competitive market, average revenue equals A) average cost. B) the change in total revenue. C) price. D) price divided by quantity.

70) A firm should continue producing until A) the cost of producing the output equals the revenues obtainable from selling the output. B) the cost of increasing output by one more unit equals the revenues obtainable from selling the extra unit. C) average costs are at a minimum. D) the average cost when another unit is produced equals the average revenue obtainable from selling the extra unit.

71) A firm seeking to maximize profits should produce at the rate of output at which A) total revenue equals total cost. B) marginal revenue equals marginal cost. C) average revenue equals average cost. D) marginal revenue equals average revenue. 72) Price equals the minimum of longrun average cost A) in a long-run equilibrium. B) in a short-run equilibrium as well as in a long-run equilibrium. C) whenever average revenue equals marginal cost. D) along a horizontal long-run supply curve, but not along an upwardsloping long- run supply curve. 73) Which of the following is NOT a characteristic of a perfectly competitive longrun equilibrium? A) Firms are making zero profits. B) Price equals marginal cost. C) Price equals long-run minimum average cost. D) Firms are producing on the downwardsloping portions of their short-run average cost curves. 74) Competitive pricing is efficient because A) the price that consumers pay reflects the opportunity cost to society of producing the good. B) firms make positive economic profits in long-run equilibrium. C) average revenue equals average cost. D) firms produce above the minimum efficient scale. 75) A market failure is a situation in which A) resources are being efficiently allocated, but some companies are forced to shut down. B) the market equilibrium leads to either too many or too few resources going towards producing the good or service. C) the government must take actions to correct the failures of the market in a particular industry. D) there is not free entry or exit into an industry. 76) If price is below average variable costs at all rates of output, the quantity supplied by a perfect competitor will equal A) zero. B) the rate of output where price equals marginal cost. C) the rate of output associated with the break even point. D) the rate of output where marginal revenue equals average fixed costs. 77) In the model of perfect competition, the market demand curve is found by A) a marketing analysis. B) taking the demand curve of a representative consumer and expanding it by the number of consumers of the good. C) horizontally summing the demand curves of individual consumers. D) horizontally summing the supply curves of individual firms.

78) Profits and losses are true market signals because they A) convey information in an asymmetrical fashion. B) convey information about where resources should flow into or out of, and they reward people who act on the information. C) convey information to public officials about where to encourage people to invest and what skills people should develop. D) cause people to move into careers in both undesirable desirable industries with equal ease. 79) A law that restricts plant closings will A) make the economy more efficient by slowing down the movement of resources to a more optimal rate. B) make the economy more efficient by reducing poor decisions on the part of entrepreneurs. C) prevent resources from flowing to their highest valued uses. D) allow profits and losses to provide a signaling function. 80) A constantcost industry A) is one in which an increase in demand is matched by a proportional increases in long-run supply. B) generates increasing profits whenever demand increases because the new longrun equilibrium price is above the old price even though average costs have not changed. C) has a horizontal long-run supply curve. D) has a downward-sloping long-run supply curve. 81) A) B) C) D) The shortrun breakeven price is the point at which price is less than marginal cost. marginal cost, average total cost and marginal revenue are all equal. average variable cost is at a minimum. marginal cost, price and average variable cost are all equal.

82) A firm is currently producing the quantity where price equals the minimum point on the average variable cost curve. If wage rates increase, the firm will A) increase its rate of output to make up for the higher variable costs. B) shut down since it would no longer be covering its variable costs. C) decrease its rate of output to offset the higher variable costs. D) not make any changes since its current rate of output is still minimizing its losses. 83) A) B) C) D) 84) A) B) C) D) Economic profits at the short-run break-even point are positive. negative. equal to zero. indeterminate since they also depend on the size of the fixed costs. Accounting profits at the firms breakeven point are positive. negative. zero. indeterminate since we need to know what demand is.

85) In a perfectly competitive market, a firms A) its total cost curve. B) its marginal cost curve equal to or above with its average variable cost curve. C) its average variable cost curve below the its total cost curve. D) its total cost curve between the shutdown point.

shortrun supply curve equals the point of intersection point of intersection with point and the break-even

86) According quantity is the A) Q = C) Q =

to the figure above, if the firm is making zero profits, what firm selling and at what price? 200; P = $4 B) Q 1000; P = $5 800; P = $4 D) Q 1200; P = $7.00

87) A firm making losses should operate in the short run as long as A) the price per unit sold is greater than the average fixed cost per unit produced. B) the price per unit sold is greater than the average variable cost per unit produced. C) marginal revenue is greater than the price per unit sold. D) the price per unit sold is equal to or greater than the marginal cost of production. 88) A) B) C) D) A firm that shuts down in the short run experiences losses equal to its total fixed costs. average variable costs. total variable costs. total variable costs minus its total fixed costs.

89) According to Table 2301A, if the price is $10 for a firm in a competitive market, then the firm should produce A) 104 units. B) 106 units. C) 108 units. D) 110 units. 90) The marginal revenue curve of a perfectly A) has a vertical intercept equal to exactly intercept for the demand curve. B) lies below the demand curve and above the C) intersects the average revenue curve from the average revenue curve. D) is also the demand curve. 91) A) B) C) D) competitive firm onehalf of the vertical average revenue curve. above at the maximum point of

Profit per unit is found by the difference between average revenue and average total cost. marginal revenue and marginal cost. total revenue and total cost. average revenue and marginal cost.

ESSAY. Write your answer in the space provided or on a separate sheet of paper.
1) What is a price taker? Discuss the assumptions used to obtain the perfectly competitive model. Answer: A price taker, or perfectly competitive firm, is a firm that must take the price of its product as given because it cannot influence the price. The model of perfect competition uses four assumptions. There is a large number of buyers and sellers such that no one has any influence on price. The product is homogeneous so the output of one firm is a perfect substitute for the output of another firm. Buyers and sellers have all the information they need to determine the lowest price and best production technique. Finally, all firms can enter of leave the industry without serious impediments. 2) Describe and explain how the perfectly competitive firms demand curve is found. Answer: The interaction of supply and demand in the industry determines the price. The firm is a price taker, so it takes the price as a given. It can sell as many units as it wants at this price. Hence, the demand curve is perfectly elastic, or horizontal, at the market price.

3) Demand curves slope down, so the demand curve of a price taker must also be downward sloping. Do you agree or disagree? Why? Answer: Individual consumers and market demand curve slope down. However, the demand curve of the competitive firm is not the demand of the firm for the good. It is the demand curve for its product it faces in the marketplace. It the firm tries to raise price consumers switch to other sellers who are charging the market price. It has no choice but to sell at the market price. 4) What does a perfectly competitive firm do to maximize profits? Answer: The perfect competitor cannot influence price so it must find the rate of output that maximizes its profits. The profitmaximizing rate of output is where marginal revenue equals marginal cost. If marginal revenue is greater than marginal cost, an additional unit increases revenues more than costs, so profits increase. If marginal revenue is less than marginal cost, a reduction in output of one unit reduces costs more than revenues, so profits increase. The maximum is when marginal revenue equals marginal cost. 5) What is the shortrun breakeven price? What are economic profits at this price? Why would a firm be willing to operate permanently at this price? Answer: The shortrun breakeven price is the price at which total revenue equals total costs, or profits are zero. That is, economic profits are zero. The firm is willing to stay in business at zero profits because all opportunity costs are covered, including the opportunity costs of the entrepreneurs time and any other resources he or she brings into the firm. The zero economic profits are associated with a normal rate of return, and the entrepreneur cannot expect to do better anywhere else. 6) What determines the perfect competitors supply curve? How is the industry supply curve found? Answer: A supply curve shows the quantity supplied at various prices. The firm decides how much to supply at each price by equating price and marginal cost. Therefore, the marginal cost curve shows the quantity supplied at each price. However, at a price below the shutdown price, output is zero, so that portion of the marginal cost curve is not part of the supply curve. The industry supply curve is found by adding the quantities supplied of each firm for each price. It is the horizontal summation of the individual firms supply curves. 7) Why does the industry short-run supply curve slope up? Answer: The industry short-run supply curve slopes up because the individual firms short-run supply curves slope up. The perfect competitors short-run supply curve slopes up because the marginal cost curve slopes up, and the marginal cost curve slopes up because of the law of diminishing marginal returns. Hence, the industry short-run supply curve slopes up because of the law of diminishing marginal returns. 8) When firms in a perfectly competitive industry are making positive profits, what happens in the long run? Answer: The profits are a signal to entrepreneurs to enter the industry, bringing resources with them, and to increase production of the good. As firms do this, the industry shortrun supply curve shifts out, price falls, and profits fall. When profits are zero, new firms will no longer enter the industry and a long- run equilibrium has been reached.

9) What are signals? How do profits function as signals? Answer: Signals are compact ways of conveying to economic decision makers information needed to make decisions. A signal not only conveys information, but also provides the incentive to react appropriately. Economic profits are such signals because they signal to entrepreneurs where they should operate, and provide the incentive in that the entrepreneurs incomes are increased when they respond to the signals. 10) What determines whether the industry long-run supply curve is upward sloping or horizontal? Answer: When firms enter and exit the industry, new resources are either drawn into the industry or are temporarily left unemployed. It these movements in resources cause resource prices to change, then the industry will be an increasing-cost industry and have an upward-sloping long-run supply curve. If these movements in resources do not affect resource prices, then the industry is a constant-cost industry and the long-run supply curve is horizontal. 11) What is marginal cost pricing? Why is marginal cost pricing important? Answer: Marginal cost pricing is a system in which price equals the opportunity cost to society of producing one more unit of the good, which is the marginal cost of the good. It is efficient in the sense that it is impossible to increase the output of any good without lowering the value of the total output produced by the society as a whole.