Economics

Please complete questions for review # 6,7 problems and applications # 4,9

·FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY

• Because a competitive firm is a price taker, its
revenue is proportional to the amount of output
it produces. The price of the good equals both the
firm’s average revenue and its marginal revenue.

• To maximize profit, a firm chooses a quantity of
output such that marginal revenue equals mar-
ginal cost. Because marginal revenue for a com-
petitive firm equals the market price, the firm
chooses quantity so that price equals marginal
cost. Thus, the firm’s marginal-cost curve is its
supply curve.

• In the short run when a firm cannot recover its
fixed costs, the firm will choose to shut down
temporarily if the price of the good is less than
average variable cost. In the long run when the
firm can recover both fixed and variable costs, it

KEY CONCI.PJ:S.
competitive market, p. 280
average revenue, p. 281

1. What is meant by a competitive firm?
2. Explain the difference between a firm’s revenue

and its profit. Which do firms maximize?
3. Draw the cost curves for a typical firm. For a

given price, explain how the firm chooses the
level of output that maximizes profit. At that
level of output, show on your graph the firm’s
total revenue and total costs.

4. Under what conditions will a firm shut down
temporarily? Explain.

1. Many small boats are made of fiberglass, which
is derived from crude oil. Suppose that the price
of oil rises.
a. Using diagrams, show what happens to the

cost curves of an individual boat-making
firm and to the market supply curve.

b. What happens to the profits of boat makers
in the short run? What happens to the
number of boat makers in the long run?

2. You go out to the best restaurant in town and
order a lobster dinner for $40. After eating half

will choose to exit if the price is less than average
total cost.

• In a market with free entry and exit, profits are
driven to zero in the long run. In this long-run
equilibrium, all firms produce at the efficient
scale, price equals the minimum of average total
cost, and the number of firms adjusts to satisfy
the quantity demanded at this price.

• Changes in demand have different effects over
different time horizons. In the short run, an
increase in demand raises prices and leads to
profits, and a decrease in demand lowers prices
and leads to losses. But if firms can freely enter
and exit the market, then in the long run, the
number of firms adjusts to drive the market back
to the zero-profit equilibrium.

marginalrevenue,p.282
sunk cost, p. 286

5. Under what conditions will a firm exit a
” market? Explain.
( 6:\Does a firm’s price equal marginal cost in the
~–thort run, in the long run, or both? Explain.
V Does a firm’s price equal the minimum of

average total cost in the short run, in the long
run, or both? Explain.

8. Are market supply curves typically more
elastic in the short run or in the long run?
Explain.

of the lobster, you realize that you are quite full.
. Your date wants you to finish your dinner because
. you can’t take it home and because “you’ve
already paid for it.” What should you do? Relate
your answer to the material in this chapter.

3. Bob’s lawn-mowing service is a profit-maximizing,
competitive firm. Bob mows lawns for $27 each.
His total cost each day is $280, of which $30 is a
fixed cost. He mows 10 lawns a day. What can you
say about Bob’s short-run decision regarding
shutdown and his long-run decision regarding exit?

total cost and total revenue given in
following table:

012 3 4 56 7

Total cost
Total revenue

$8 9 10
$0 8 16

11 13 19 27 37
. ‘ ‘ 24 32 40 48 .Sf> ·

a. Calculate profit for each quantity. How much
should the firm produce to maximize profit?

b. Calculate marginal revenue and marginal
cost for each quantity. Graph them. (Hint:
Put the points between whole numbers. For
example, the marginal cost between 2 and 3
should be graphed at 2~.) At what quantity
do these curves cross? How does this relate
to your answer to part (a)?

c. Can you tell whether this firm is in a
competitive industry? If so, can you tell
whether the industry is in a long-run
equilibrium?

5. Ball Bearings, Inc. faces costs of production as
follows:

Total Total
Fixed Variable

Quantity Costs Costs

0 $100 $ 0
1 100 50
2 100 70
3 100 90
4 100 140
5 100 200
6 100 360

a. Calculate the company’s average fixed costs,
average variable costs, average total costs, an~
marginal costs at each level of production.

b. The price of a case of ball bearings is $50.
Seeing that she can’t make a profit, the Chief
Executive Officer (CEO) decides to shut
down operations. What are the firm’s profits/
losses? Was this a wise decision? Explain.

c. Vaguely remembering his introductory
economics coutse, the Chief Financial Officer
tells·the CEO it is better to produce 1 case
of ball bearings, because marginal revenue
equals marginal cost at that quantity. What
are the firm’s profits/losses at that level
of production? Was this the best decision?
Explain.

6. Suppose the book-printing industry is competitive
and begins in a long-run equilibrium.
a. Draw a diagram describing the typical firm

in the industry.
b. Hi-Tech Printing Company invents a new

process that sharply reduces the cost of

CHAPTER 14 FIRMS IN COMPETITIVE MARKETS

printing books. What happens to Hi-Tech’s
profits and the price of books in the short run
when Hi-Tech’s patent prevents other firms
from using the new technology?

c. What happens in the long run when the
pat~nt expires and other firms are free to use
the technology?

7. A firm in a competitive market receives $500 in
total revenue and has marginal revenue of $10.
What is the average revenue, and how many
units were sold? .

8. A profit-maximizing firm in a competitive
market is currently producing 100 units of
output. It has average revenue of $10, average
total cost of $8, and fixed costs of $200.
a. What is its profit?
b. What is its marginal cost?
c. What is its average variable cost?
d. Is the efficient scale of the firm more than,

~
less than, or exactly 100 units?

The market for fertilizer is perfectly competitive.
Firms in the market are producing output, but
are currently making economic losses.
a. How does the price of fertilizer compare to

the· average total cost, the average variable
cost, and the marginal cost of producing
fertilizer?

b. Draw two graphs, side by side, illustrating
the present situation for the typical firm and
in the market. ‘

c. Assuming there is no change in either
demand or the firms’ cost curves, explain
what will happen in the long run to the price
of fertilizer, marginal cost, average total cost,
the quantity supplied by each firm, and the
total quantity supplied to the market.

10. The market for apple pies in the city of Ectenia
is competitive and has the following demand
schedule:

Price Quantity Demanded

$ 1 1.200 pies
2 1,100
3 1,000
4 %0
5 800
6 700
7 600
8 500
9 400

10. . 300

11 200
12 100
13 0 .