Me11e 10

4,083 views
3,933 views

Published on

Published in: Business, Economy & Finance
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
4,083
On SlideShare
0
From Embeds
0
Number of Embeds
0
Actions
Shares
0
Downloads
60
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Me11e 10

  1. 1. CHAPTER7—PERFECT COMPETITION MULTIPLE CHOICE1. If P = $8 and MC = $5 + 0. 2Q, the competitive firms profit-maximizing level of output is: a. 5b.0.2c.8d.15 ANS: D In the long run, firms will offer supply at the point where P = MR = MC if: a.MC is rising.b.MC is falling.c.MC is constant.d.P > AC ANS: D Graphically, competitive market supply is measured by the: a.vertical difference of competitor demand curves.b.vertical sum of competitor demand curves.c.horizontal difference of competitor MC curves.d.horizontal sum of competitor MC curves. ANS: D For a firm in perfectly competitive market equilibrium: a.MR < ARb.P > ACc.P > MRd.P = MC ANS: D Competition tends to be light when: a.potential entrants are few.b.capital requirements are nominal.c.standards for skilled labor and other inputs are modest.d.regulatory barriers are modest. ANS: A By itself, a reduction in import tariffs (taxes) will: a.reduce quantity demanded.b.enhance domestic competition.c.enhance the profits of domestic competitors.d.reduce import competition. ANS: B Above-normal profits in a perfectly competitive market are caused by: a.increases in demand that are successfully anticipated.b.decreases in cost that are successfully anticipated.c.increases in productivity that are successfully anticipated.d.luck. ANS: D In a perfectly competitive market: a.sellers and buyers have perfect information.b.entry and exit are difficult.c.sellers produce similar, but not identical products.d.each seller can affect the market price by changing output. ANS: A The firm demand curve in a competitive market is: a.upward sloping.b.downward sloping.c.horizontal.d.vertical. ANS: C
  2. 2. A firm will earn normal profits when price:a.equals average total cost.b.equals average variable cost.c.equals marginal cost.d.exceedsminimum average total cost.ANS: AIn the short run, a perfectly competitive firm will shut down and produce nothing if:a.excess profits equal zero.b.total cost exceeds total revenue.c.total variable cost exceedstotal revenue.d.the market price falls below the minimum average total cost.ANS: CIn the long run, firms will exit a perfectly competitive industry if:a.excess profits exceed zero.b.excess profits are less than zero.c.total profit equalszero.d.excess profits equal zero.ANS: BPerfect competition always prevails in markets with:a.few buyers and sellers.b.many buyers and sellers.c.an even balance of power betweensellers and buyers.d.a single buyer.ANS: CIn perfectly competitive markets, profits are maximized when:a.MC = ACb.P > ACc.MR = MCd.MR = PANS: CEconomic profit:a.cannot be negative.b.can exceed the risk-adjusted normal rate of return.c.is less than therisk-adjusted normal rate of return.d.does not reflect the cost of owner-supplied inputs.ANS: BMarket structure is not typically characterized on the basis of:a.the number and size distribution of active buyers and sellers.b.potential entrants.c.exitbarriers.d.government regulation.ANS: DEffects of market structure are not typically measured in terms of:a.the prices paid by consumers.b.declining consumer popularity.c.employmentopportunities.d.pace of product innovation.ANS: BPrice and product quality competition tends to be vigorous when:a.entry barriers are low.b.potential entrants are few.c.product quality information isscarce.d.the number of active sellers is few.ANS: AIndustry cartels never:a.give rise to price supports.b.spur entry when barriers to entry are low.c.spur exit whenexit barriers are low.d.prompt inefficiency and waste.ANS: C
  3. 3. The rate of return necessary to attract and retain capital investment is called:a.ROE.b.economic losses.c.normal profit.d.economic profit.ANS: CIn competitive market equilibrium, the firms:a.MR = MC and P > ARb.MR = MC and P > ACc.AR = AC and MR > MCd.P = MR = AR= AC = MCANS: DAt the point of minimum AVC:a.MC is falling.b.MC is constant.c.MC is rising.d.MC = AVC.ANS: DSo long as P > AVC, the competitive firms short-run supply curve is equal to:a.AVCb.Pc.MCd.none of these.ANS: CWhen profits are maximized in a competitive market, average cost is always:a.rising.b.falling.c.constant.d.none of these.ANS: DThe following market cannot be described as perfectly competitive:a.the unskilled labor market.b.the milk market.c.discount retailing.d.the agricultural grainmarkets.ANS: BPROBLEMCompetitive Markets. Indicate whether each of the following statements is true or falseand why.A.In long-run equilibrium, every firm in a perfectly competitive industry earns aneconomic profit.B.Pure competition exists in a market when firms are price makers asopposed to price takers.C.A natural monopoly results when the profit-maximizing outputlevel occurs at a point where long-run average costs are decreasing.D.Downward-slopingindustry demand curves characterize monopoly markets; horizontal demand curvescharacterize perfectly competitive markets.E.A decrease in the price elasticity of demandwould follow an increase in monopoly power.ANS:A.False. In long-run equilibrium, every firm in a perfectly competitive industry earns zeroexcess profit. Following a decrease in industry prices, high cost producers will be forcedto exit. However, the firms that remain will continue to operate and earn a normal rate ofreturn on investment.B.False. Pure competition exists in a market when individual firmshave no influence over price. Such firms take industry prices as a given.C.False. A naturalmonopoly occurs in a market when the market clearing price, or price where Demand(Price) = Supply (Marginal Cost), occurs at an output level where long-run average costsare declining.D.False. Downward sloping demand curves follow from the law of
  4. 4. diminishing marginal utility and characterize both perfectly competitive and monopolymarket structures. Horizontal demand curves characterize perfectly competitivefirms.E.True. A decrease in the price elasticity of demand would result following anincrease in monopoly power.Market Structure. Specify whether each of the following statements is true or false anddemonstrate why.A.A market is confined to all firms and individuals willing and able to buy or sell aparticular product at a given time and place.B.The more even the balance of powerbetween sellers and buyers, the more likely it is that the competitive process will yieldmaximum benefits.C.A close link between the numbers of market participants and thevigor of price competition is always evident.D.Market structure describes the competitiveenvironment in the market for any good or service.E.Competitors often benefit from theeffects of potential entrants in industries with only a handful of viable firms.ANS:A.False. A market consists of all firms and individuals willing and able to buy or sell aparticular product at a given time and place. This includes individuals and firms currentlyengaged in buying and selling a particular product, as well as potential entrants.B.True.The more even the balance of power between sellers and buyers, the more likely it is thatthe competitive process will yield maximum benefits.C.False. A close link between thenumbers of market participants and the vigor of price competition does not always holdtrue. For example, there are literally thousands of producers in most major milk markets.Price competition is nonexistent, however, given an industry cartel that is sustained by afederal program of milk price supports. Nevertheless, there are few barriers to entry, andindividual milk producers struggle to earn a normal return.D.True. Market structure istypically characterized on the basis of four important industry characteristics: the numberand size distribution of active buyers and sellers and potential entrants, the degree towhich products are similar or dissimilar, the amount and cost of information about productprice and quality, and conditions of entry and exit.E.False. Consumer, not competitors,often benefit from the effects of potential entrants in industries with only a handful ofviable firms. Price competition can be spirited in aircraft manufacturing, newspaper,Internet access, long-distance telephone service, and other markets with as few as twocompetitors. This is particularly true when market participants are constrained by theviable threat of potential entrants.Product Differentiation. Suggest whether each of the following statements is true or falseand illustrate why.A.Sources of product differentiation include only physical differences, not merelyperceived differences.B.Price competition tends to be most vigorous for products withmany actual or perceived differences.C.The availability of good substitutes decreases thedegree of competition.D.Competition tends to be less vigorous when buyers and sellershave easy access to detailed price/product performance information.E.The availability ofgood complements increases the degree of competition.ANS:A.False. Real or perceived differences in the quality of goods and services offered toconsumers lead to product differentiation. Sources of product differentiation includephysical differences, such as those due to superior research and development, plus anyperceived differences due to effective advertising and promotion.B.False. Price
  5. 5. competition tends to be most vigorous for homogenous products with few actual orperceived differences.C.False. The availability of good substitutes increases the degree ofcompetition.D.False. Competition is always most vigorous when buyers and sellers haveeasy access to detailed price/product performance information.E.False. The availability ofgood substitutes increases the degree of competition.Entry and Exit Conditions. Signify whether each of the following statements is true orfalse and document why.A.A barrier to mobility is any factor or industry characteristic that creates an advantage forincumbents over new arrivals.B.A barrier to entry is any factor or industry characteristicthat creates an advantage for large leading firms over smaller nonleading rivals.C.Barriersto entry and mobility sometimes result in compensating advantages for consumers.D.Abarrier to exit is any restriction on the ability of incumbents to redeploy assets from oneindustry or line of business to another.E.Government actions that create barriers to exit canhave the unintended effect of retarding industrial development.ANS:A.False. A barrier to entry is any factor or industry characteristic that creates an advantagefor incumbents over new arrivals.B.False. A barrier to mobility is any factor or industrycharacteristic that creates an advantage for large leading firms over smaller non-leadingrivals.C.True. It is worth keeping in mind that barriers to entry and mobility cansometimes result in compensating advantages for consumers. Even though patents canlead to monopoly profits for inventing firms, they also spur valuable new product andprocess development. Although efficient and innovative leading firms make life difficultfor smaller rivals, they can have the favorable effect of lowering prices and increasingproduct quality. Therefore, a complete evaluation of the economic effects of entry barriersinvolves a consideration of both costs and benefits realized by suppliers andcustomers.D.True. A barrier to exit is any restriction on the ability of incumbents toredeploy assets from one industry or line of business to another. During the late 1980s, forexample, several state governments initiated legal proceedings to impede plant closures bylarge employers in the steel, glass, automobile, and other industries. By imposing largefines or severance taxes or requiring substantial expenditures for worker retraining, theycreated significant barriers to exit.E.True. By impeding the asset redeployment that istypical of any vigorous competitive environment, barriers to exit can dramatically increaseboth the costs and risks of doing business. Even though one can certainly sympathize withthe difficult adjustments faced by both workers and firms affected by plant closures,government actions that create barriers to exit can have the unintended effect of retardingindustrial development.Price/Output Determination. Cold Case, Inc., produces beverage containers used by fastfood franchises. This is a perfectly competitive market. The following relation existsbetween the firms beverage container output per hour and total production costs: Total OutputTotal Cost0$ 351,000852,0001453,0002154,0002955,0003856,0004857,000610A.Construct a table showing the marginal cost of paper cup production.B.What is theminimum price necessary for the company to supply one thousand cups?C.How manycups would the company supply at industry prices of $75 and $100 per thousand?ANS:
  6. 6. A.Total OutputTotal CostMarginalCost0$ 35--1,00085$ 502,000145603,000215704,000295805,000385906,0004851007,00 0610125B.The minimum marginal cost of cups is $50, so this also represents the minimum price necessary to justify supplying a thousand units of output.C.In a perfectly competitive market, P = MR. Therefore, E. R. will supply output so long as price at leastcovers the marginal cost of production. At a price of $75, Q = 3,000 units of output can be justified because P = $75 > MCQ = 3,000 = $70. However, production of a fourth unit is not warranted because P = $75 < MCQ = 4,000 = $80. Similarly, Q = 6,000 could be justified at a price of $100 because P = $100 = MCQ = 6,000.Firm Supply. The Copy Center specializes in high-volume printing and color copying forsmall businesses. This is a fiercely competitive market. The following relation existsbetween output and total production costs: Total OutputTotalCost0$ 50010,0003,50020,0007,50030,00012,50040,00018,50050,00025,50060,00033, 50070,00045,000A.Construct a table showing the marginal of production.B.What is the minimum pricenecessary for the company to supply ten thousand copies?C.How many copies would thecompany supply at industry prices of $5,500 and $7,000 per ten thousand?ANS: A.Total OutputTotal CostMarginalCost0$ 500--10,0003,500$ 3,00020,0007,5004,00030,00012,5005,00040,00018,5006,0 0050,00025,5007,00060,00033,5008,00070,00045,00011,500B.The minimum marginal cost of copies per 10,000 units is $3,000, so this also represents the minimum price necessary to justify supplying ten thousand units of output.C.In a perfectly competitive market, P = MR. Therefore, the company will supply output so long as price at least covers the marginal cost of production. At a price of $5,500, Q = 30,000 units of output can be justified because P = $5,500 > MCQ = 30,000 = $5,000. However, production of a fourth unit is not warranted because P = $5,500 < MCQ = 40,000 = $6,000. Similarly, Q = 50,000 could be justified at a price of $7,000 because P = $7,000 = MCQ = 50,000.Firm Supply. Credit Check, Inc., offers credit checking services to credit card companiesand retailers. The following relation exists between the number of credit checks performedand total costs in this viciously competitive market: Total OutputTotal Cost0$ 1501,0006002,0001,0603,0001,5404,0002,0405,0002,5656,0003,1157,0003,750A.Construct a table showing the marginal cost of production.B.What is the minimum pricenecessary for the firm to supply one thousand credit checks?C.How many credit checkswould the firm perform at industry prices of $510 and $550 per thousand?ANS:
  7. 7. A.Total OutputTotal CostMarginal Cost0$ 150--1,000600$4502,0001,0604603,0001,5404804,0002,0405005,0002,5655256,0003,1155507 ,0003,750635B.The minimum marginal cost of output is $450, so this also represents the minimum price necessary to justify supplying one thousand units of output.C.In a perfectly competitive market, P = MR. Therefore, the firm will supply output so long asprice at least covers the marginal cost of production. At a price of $510, Q = 4,000 units of output can be justified because P = $510 > MCQ = 4,000 = $500. However, production of a fifth unit is not warranted because P = $510 < MCQ = 5,000 = $525. Similarly, Q = 6,000 could be justified at a price of $550 because P = $550 = MC Q = 6,000.Firm Supply. Retirement Planning Services.com is a wholesale producer of standardizedretirement plans for high net worth individuals. These plans are produced and e-mailed tofinancial planners who incorporate them in their client presentations. The followingrelation exists between the firms output and total production costs in this highly price-competitive market: Total OutputTotal Cost0$ 501001502002753004254006005008006001,0507001,350A.Construct a table showing the firms marginal cost of production.B.What is theminimum price necessary for the firm to supply one hundred plans?C.How many planswould the firm supply at industry prices of $180 and $300 per hundred?ANS: A.Total OutputTotal CostMarginal Cost0$ 50-- 100150$1002002751253004251504006001755008002006001,0502507001,350300B.The minimum marginal cost is $100, so this also represents the minimum price necessary to justify supplying one hundred units of output.C.In a perfectly competitive market, P = MR. Therefore, the company will supply output so long as price at least covers the marginal cost of production. At a price of $180, Q = 400 units of output can be justified because P = $180 > MCQ = 400 = $175. However, production of a fourth unit is not warranted because P = $180 < MCQ = 500 = $200. Similarly, Q = 700 could be justified at a price of $300 because P = $300 = MCQ = 700.Long-run Firm Supply. The Los Angeles retail market for unleaded gasoline is fiercelyprice competitive. Consider the situation faced by a typical gasoline retailer when the localmarket price for unleaded gasoline is $2.50 per gallon and total cost (TC) and marginalcost (MC) relations are:TC = $156,250 + $2.25Q + $0.0000001Q2MC = ∂TC/∂Q = $2.25 + $0.0000002Qand Q is gallons of gasoline. Total costs include a normal profit.
  8. 8. A.Using the firms marginal cost curve, calculate the profit-maximizing long-run supplyfrom a typical retailerB.Calculate the average total cost curve for a typical gasolineretailer, and verify that average total costs are less than price at the optimal activity level.ANS:A.The marginal cost curve constitutes the long-run supply curve for firms in perfectlycompetitive markets if price is greater than average total cost. Because P = MR, the pricenecessary to induce firm supply in the long run of a given amount is found by setting P =MC, provided that P > ATC:P = $2.25 + $0.0000002Q2.50 = $2.25 + $0.0000002Q0.25 =0.0000002QQ = 1,250,000B.The average total cost curve is determined by dividing totalcost by output:ATC = ($156,250 + $2.25Q + $0.0000001Q2)/Q = $156,250/Q + $2.25 +$0.0000001QAt the Q = 1,250,000 activity level, average total cost is $2.50 and just equalto the market price:ATC = $156,250/1,250,000 + $2.25 + $0.0000001(1,250,000) =$2.50Because P = MR = MC and P = ATC at the 1,250,000 gallons per year activity level,this is a sustainable amount of long-run supply from the typical gasoline retailer. With noeconomic profits being earned in the industry, there will be no incentive to either grow orcontract and only a normal profit is earned by each competitor in long-run equilibrium.Long-run Firm Supply. The Boston retail market for unleaded gasoline is fiercely pricecompetitive. Consider the situation faced by a typical gasoline retailer when the localmarket price for unleaded gasoline is $1.80 per gallon and total cost (TC) and marginalcost (MC) relations are:TC = $400,000 + $1.64Q + $0.0000001Q2MC = ∂TC/∂Q = $1.64 + $0.0000002Qand Q is gallons of gasoline. Total costs include a normal profit.A.Using the firms marginal cost curve, calculate the profit-maximizing long-run supplyfrom a typical retailerB.Calculate the average total cost curve for a typical gasolineretailer, and verify that average total costs are less than price at the optimal activity level.ANS:A.The marginal cost curve constitutes the long-run supply curve for firms in perfectlycompetitive markets if price is greater than average total cost. Because P = MR, the pricenecessary to induce firm supply in the long run of a given amount is found by setting P =MC, provided that P > ATC:P = $1.64 + $0.0000002Q1.80 = $1.64 + $0.0000002Q0.16 =0.0000002QQ = 800,000B.The average total cost curve is determined by dividing totalcost by output:ATC = ($400,000 + $1.64Q + $0.0000001Q2)/Q = $400,000/Q + $1.64 +$0.0000001QAt the Q = 800,000 activity level, average total cost is $2.22 and more thanthe market price:ATC = $400,000/800,000 + $1.64 + $0.0000001(800,000) =$2.22Because P = MR = MC while P < ATC at the 800,000 gallons per year activity level,this is not a sustainable amount of long-run supply from the typical gasoline retailer.Economic losses being suffered in the industry will cause exit until prices rise or costs fallsufficiently to ensure that only a normal profit is earned by each competitor in long-runequilibrium.Short-run Firm Supply. Produce Pride, Inc., supplies sweet corn to canneries locatedthroughout the Missouri River Valley. Like many grain and commodity markets, themarket for sweet corn is perfectly competitive. With $500,000 in fixed costs, the
  9. 9. companys total and marginal costs per ton (Q) are:TC = $500,000 + $400Q + $0.04Q2MC = ∂TC/∂Q = $400 + $0.08QA.Calculate the industry price necessary to induce short-run firm supply of 5,000, 10,000,and 15,000 tons of sweet corn. Assume that MC > AVC at every point along the firmsmarginal cost curve and that total costs include a normal profit.B.Calculate short-run firmsupply at industry prices of $400, $1,000, and $2,000 per ton.ANS:A.The marginal cost curve constitutes the short-run supply curve for firms in perfectlycompetitive industries provided price exceeds average variable cost. Because P = MR, theprice necessary to induce short-run firm supply of a given amount is found by setting P =MC, assuming P > AVC. Here:MC = ∂TC/∂Q = $400 + $0.08QTherefore, at:Q = 5,000: P= MC = $400 + $0.08(5,000) = $800Q = 10,000: P = MC = $400 + $0.08(10,000) =$1,200Q = 15,000: P = MC = $400 + $0.08(15,000) = $1,600(Note: Variable Cost =$400Q + $0.04Q2, and AVC = $400 + $0.04Q, so MC > AVC at each point along the firmsshort-run supply curve.)B.When quantity is expressed as a function of price, the firms supply curve can bewritten:P = MC = $400 + $0.08Q0.08Q = -400 + PQ = -5,000 + 12.5PTherefore, at:P =$400: Q = -5,000 + 12.5($400) = 0P = $1,000: Q = -5,000 + 12.5($1,000) = 7,500P =$2,000: Q = -5,000 + 12.5($2,000) = 20,000Short-run Firm Supply. Natures Best, Inc., supplies asparagus to canners locatedthroughout the Mississippi River valley. Like several grain and commodity markets, themarket for asparagus is perfectly competitive. Marginal cost per ton of asparagus is:MC = $1.50 + $0.0005QA.Calculate the industry price necessary for the firm to supply 500, 1,000, and 2,000pounds.B.Calculate the quantity supplied by Natures Best at industry prices of $1.50,$2.25, and $2.75 per pound.ANS:A.The marginal cost curve constitutes the supply curve for firms in perfectly competitiveindustries. Because P = MR, the price necessary to induce supply of a given amount isfound by setting P = MC. Therefore, at:Q = 500:P = MC = $1.50 + $0.0005(500) = $1.75Q= 1,000:P = MC = $1.50 + $0.0005(1,000) = $2.00Q = 2,000:P = MC = $1.50 +$0.0005(2,000) = $2.50B.When quantity is expressed as a function of price, the firms supply curve can bewritten:P = MC = $1.50 + $0.0005Q0.0005Q = P - 1.50Q = 2,000P - 3,000Therefore, at:P= $1.50:Q = 2,000(1.50) - 3,000 = 0P = $2.25:Q = 2,000(2.25) - 3,000 = 1,500P = $2.75:Q= 2,000(2.75) - 3,000 = 2,500Short-run Firm Supply. Whole Fruit, Inc., distributes oranges to wholesalers locatedthroughout the country. Like several grain and commodity markets, the market for orangesis perfectly competitive. The marginal cost per crate of oranges is:MC = $15 + $0.0001Q
  10. 10. A.Calculate the industry price necessary for the firm to supply 25,000, 50,000, and100,000 crates.B.Calculate the quantity supplied by Whole Fruit at industry prices of $15,$22.50, and $27.50 per crate.ANS:A.The marginal cost curve constitutes the supply curve for firms in perfectly competitiveindustries. Because P = MR, the price necessary to induce supply of a given amount isfound by setting P = MC. Therefore, at:Q = 25,000:P = MC = $15 + $0.0001(25,000) =$17.50Q = 50,000:P = MC = $15 + $0.0001(50,000) = $20Q = 100,000:P = MC = $15 +$0.0001(100,000) = $25B.When quantity is expressed as a function of price, the firms supply curve can bewritten:P = MC = $15 + $0.0001Q0.0001Q = P - 15Q = 10,000P - 150,000Therefore, at:P= $15:Q = 10,000(15) - 150,000 = 0P = $22.50:Q = 10,000(22.50) - 150,000 = 75,000P =$27.50:Q = 10,000(27.50) - 150,000 = 125,000Short-run Firm Supply. Give Me a Pane, Inc., distributes window glass to hardware andbuilding supply chains located throughout the Northeast. Like several grain andcommodity markets, the market for common single-pane glass is perfectly competitive.The companys technology defines a marginal cost per pound of single-pane glass givenby the relation:MC = $1.00 + $0.0001Qwhere Q is pounds of single-pane glass.A.Calculate the industry price necessary for the firm to supply 10,000, 20,000, and 30,000pounds.B.Calculate the quantity supplied by the firm at industry prices of $1.50, $2.50,and $3.50 per pound.ANS:A.The marginal cost curve constitutes the supply curve for firms in perfectly competitiveindustries. Because P = MR, the price necessary to induce supply of a given amount isfound by setting P = MC. Therefore, at:Q = 10,000:P = MC = $1.00 + $0.0001(10,000) =$2Q = 20,000:P = MC = $1.00 + $0.0001(20,000) = $3Q = 30,000:P = MC = $1.00 +$0.0001(30,000) = $4B.When quantity is expressed as a function of price, the firms supply curve can bewritten:P = MC = $1.00 + $0.0001Q0.0001Q = P - 1.00Q = 10,000P - 10,000Therefore,at:P = $1.50:Q = 10,000(1.50) - 10,000 = 5,000P = $2.50:Q = 10,000(2.50) - 10,000 =15,000P = $3.50:Q = 10,000(3.50) - 10,000 = 25,000Long-run Competitive Firm Supply. Calvins Barbershop is a popularly-priced haircutter on the south side of Chicago. Given the large number of competitors, the fact thatbarbers routinely tailor services to meet customer needs, and the lack of entry barriers, it isreasonable to assume that the market is perfectly competitive and that the average $15price equals marginal revenue, P = MR = $15. Furthermore, assume that the barbershopsmonthly operating expenses are typical of the 50 barbershops in the local market and canbe expressed by the following total and marginal cost functions:TC = $7,812.50 + $2.5Q + $0.005Q2MC = $2.5. + $0.01Q
  11. 11. where TC is total cost per month including capital costs, MC is marginal cost, and Q is thenumber of hair cuts provided. Total costs include a normal profit.A.Calculate Calvins profit-maximizing output level.B.Calculate the Calvins economicprofits at this activity level. Is this activity level sustainable in the long run?ANS:A.The optimal output level can be determined by setting marginal revenue equal tomarginal cost and solving for Q:MR = MC$15 = $2.50 + $0.01Q$0.01Q = $12.50Q =1,250 hair cuts per month.B.Because the cost of capital is already included in the total cost function, any excess ofrevenues over total cost represents economic profits. At this output level, maximumeconomic profits areπ = TR - TC = $15Q - $7,812.5. - $2.5Q - $0.005Q2 = $15(1,250) -$7,812.5. - $2.5(1,250) - $0.005(1,2502) = $0The Q = 1,250 activity level results in zeroeconomic profits. This means that the barbershop is just able to obtain a normal or risk-adjusted rate of return on investment because capital costs are already included in the costfunction. The Q = 1,250 output level is also the point of minimum average productioncosts (ATC = MC = $15), and thereby constitutes the firms long-run sustainable supply.Finally, with 500 identical firms in the local area, industry output totals 62,500 hair cutsper month.Short-run Market Supply. Carolina Textiles, Inc., is a small manufacturer of cotton linenthat it sells in a perfectly competitive market. Given $100,000 in fixed costs per day, thedaily total cost function for this product is described by:TC = $100,000 + $2Q + $0.0625Q2MC = ∂TC/∂Q = $2 + $0.125Qwhere Q is units of cotton linen produced per day. Assume that MC > AVC at every pointalong the firms marginal cost curve, and that total costs include a normal profit.A.Derive the firms supply curve, expressing quantity as a function of price.B.Derive themarket supply curve if North Carolina Textiles is one of 1,000 competitors.C.Calculatemarket supply per day at a market price of $47 per unit.ANS:A.The perfectly competitive firm will supply output so long as it is profitable to do so.Because P = MR in perfectly competitive markets, the firm supply curve is given by therelation:P = MC = ∂TC/∂Q = $2 + $0.125Qwhen quantity is expressed as a function ofprice, the firm supply curve is:P = $2 + $0.125Q0.125Q = -2 + PQS = -16 + 8P(Note:Variable Cost = $2Q + $0.0625Q2, and AVC = $2 + $0.0625Q, so MC > AVC at each pointalong the firms short-run supply curve.)B.If the company is one of 1,000 such competitors, the industry supply curve is found bysimply multiplying the firm supply curve derived in part A by 1,000. This is equivalent toa horizontal summation of all 1,000 individual firm supply curves. When quantity isexpressed as a function of price:QS = 1,000 × (-16 + 8P) = -16,000 + 8,000PWhen price isexpressed as a function of quantity:QS = -16,000 + 8,000P8,000P = 16,000 + QSP = $2 +$0.000125QS
  12. 12. C.QS = -16,000 + 8,000P = -16,000 + 8,000($47) = 360,000 units per dayShort-run Market Supply. The Fertilizer Supply Co. is a typical distributor in theperfectly competitive fertilizer supply industry. Its marginal cost of output is:MC = $250 + $0.05Qwhere Q is tons of fertilizer produced per year.A.Derive the firms supply curve, expressing quantity as a function of price.B.Derive theindustry supply curve if the firm is one of 400 competitors.C.Calculate industry supply peryear at a market price of $300 per ton.ANS:A.The perfectly competitive firm will supply output so long as it is profitable to do so.Because P = MR in perfectly competitive markets, the firm supply curve is given by therelation:P = MC = $250 + $0.05Qwhen quantity is expressed as a function of price, thefirm supply curve is:P = $250 + $0.05Q0.05Q = P - 250QS = -5,000 + 20PB.If the company is one of 400 such competitors, the industry supply curve is found bysimply multiplying the firm supply curve derived in part A by 400. This is equivalent to ahorizontal summation of all 400 individual firm supply curves. When quantity is expressedas a function of price we find:Q S = 400(-5,000 + 20P) = -2,000,000 + 8,000PWhen priceis expressed as a function of quantity:QS = -2,000,000 + 8,000P8,000P = 2,000,000 + QSP= $250 + $0.000125QSC.QS = -2,000,000 + 8,000P = -2,000,000 + 8,000($300) = 400,000Short-run Market Supply. Motor City Music is a local distributor of musical CDsfeaturing compilations of classic rock recordings by various artists. Motor Citys marginalcost of output is described by the relation:MC = $2.50 + $0.00025Qwhere Q is CDs sold per year.A.Derive the firms supply curve, expressing quantity as a function of price.B.Derive theindustry supply curve if the firm is one of 100 competitors.C.Calculate industry supply peryear at a market price of $5 per unit.ANS:A.The perfectly competitive firm will supply output so long as it is profitable to do so.Because P = MR in perfectly competitive markets, the firm supply curve is given by therelation:P = MC = $2.50 + $0.00025Qwhen quantity is expressed as a function of price,the firm supply curve is:P = $2.50 + $0.00025Q0.00025Q = P - 2.50QS = -10,000 + 4,000PB.If the company is one of 100 such competitors, the industry supply curve is found bysimply multiplying the firm supply curve derived in part A by 100. This is equivalent to ahorizontal summation of all 100 individual firm supply curves. When quantity is expressedas a function of price we find:QS = 100(-10,000 + 4,000P) = -1,000,000 + 400,000PWhenprice is expressed as a function of quantity:Q S = -1,000,000 + 400,000P400,000P =1,000,000 + QSP = $2.50 + $0.0000025QS
  13. 13. C.QS = -1,000,000 + 400,000P = -1,000,000 + 400,000($5) = 1,000,000Short-run Market Supply. The Magazine Delivery Company is a typical firm in theperfectly competitive magazine delivery business. The company delivers magazines andstocks magazine racks at convenience stores located throughout the state of Kentucky.Marginal costs of service are described by the relation:MC = $5 + $0.4Qwhere Q is racks of magazines delivered and serviced per week.A.Derive the firms supply curve, expressing quantity as a function of price.B.Derive themarket supply curve if the company is one of 200 competitors.C.Calculate market supplyper week at a market price of $25 per rack delivered and serviced.ANS:A.The perfectly competitive firm will supply output so long as it is profitable to do so.Because P = MR in perfectly competitive markets, the firm supply curve is given by therelation:P = MC = $5 + $0.4Qwhen quantity is expressed as a function of price, the firmsupply curve is:P = $5 + $0.4QS0.4QS = P - 5QS = -12.5. + 2.5PB.If the company is one of 200 such competitors, the industry supply curve is found bysimply multiplying the firm supply curve derived in part A by 200. This is equivalent to ahorizontal summation of all 200 individual firm supply curves. When quantity is expressedas a function of price:QS = 200(-12.5. + 2.5P) = -2,500 + 500PWhen price is expressed asa function of quantity:QS = -2,500 + 500P500P = 2,500 + QSP = $5 + $0.002QSC.QS = -2,500 + 500P = -2,500 + 500($25) = 10,000 per weekPerfectly Competitive Equilibrium. Fuel costs have risen sharply during recent years asconsumption, refining and production costs have increased. Demand and supplyconditions in the perfectly competitive domestic crude oil market are:P = $105 - 1.5QD(Demand)P = $37.50+ 0.75QS(Supply)where P is price per barrel and Q is quantity in millions of barrels per day.A.Graph industry demand and supply curves.B.Determine both graphically andalgebraically the equilibrium industry price/output combination.ANS:
  14. 14. A.B.From the graph, it is clear that Q D = QS = 30(000,000) at a price of $60 per barrel. Thus,P = $60 and Q = 30(000,000) is the equilibrium price/output combination.Algebraically,PD = PS$105 - $1.5QD = $37.50 + $0.75QS2.25Q = 67.50Q = 30At Q = 30,the price for demand and supply equal $60 because:Demand: P = $105 - $1.5(30) =$60Supply: P = $37.50 + $0.75(30) = $60Perfectly Competitive Equilibrium. Lawn mowing services are supplied by a host ofindividuals in the suburb of Westbrook. Demand and supply conditions in the perfectlycompetitive domestic for lawn mowing services are:P = $75 - 1.75QD(Demand)P = $2QS(Supply)where P is price per lawn mowed and Q is quantity of lawns mowed per day.A.Algebraically determine the equilibrium industry price/output combination.B.Confirmthis by graphing industry demand and supply curves.ANS:A.Algebraically,PD = PS$75 - $1.75QD = $2QS3.75Q = 75Q = 20At Q = 20, the price fordemand and supply equal $40 because:Demand: P = $75 - $1.75(20) = $40Supply: P =$2(20) = $40B.From the graph, it is clear that QD = QS = 20 at a price of $40 per lawn mowed. Thus,P = $40 and Q = 20 is the equilibrium price/output combination.
  15. 15. Perfectly Competitive Equilibrium. Fuel costs have risen quickly during recent years asconsumption, refining and production costs have risen sharply. Supply and demandconditions in the perfectly competitive domestic crude oil market are:QS = -60 + 2P(Supply)QD = 90 - P(Demand)where Q is quantity in millions of barrels per day, and P is price per barrel.A.Graph industry supply and demand curves.B.Determine both graphically andalgebraically the equilibrium industry price/output combination.ANS:A.B.From the graph, it is clear that QD = QS = 40(000,000) at a price of $50 per barrel. Thus,P = $50 and Q = 40(000,000) is the equilibrium price/output combination.Algebraically,QD = QS90 - P = -60 + 2P3P = 150P = $50Both demand and supply equal
  16. 16. 40(000,000) because:Demand: QD = 90 - 1(50) = 40(000,000)Supply: QS = -60 + 2(50) =40(000,000)Perfectly Competitive Equilibrium. Office building maintenance plans call for thestripping, waxing, and buffing of ceramic floor tiles. This work is often contracted out tooffice maintenance firms, and both technology and labor requirements are very basic.Supply and demand conditions in this perfectly competitive service market in St. Paul,Minnesota are:QS = -20 + 2P(Supply)QD = 80 - 2P(Demand)where Q is thousands of hours of floor reconditioning per month, and P is the price perhour.A.Algebraically determine the market equilibrium price/output combination.B.Use a graphto confirm your answer.ANS:A.Algebraically,QD = QS80 - 2P = -20 + 2P4P = 100P = $25 per hourBoth demand andsupply equal 30(000) because:Demand: QD = 80 - 2($25) = 30(000)Supply: QS = -20 +2($25) = 30(000)B.From the graph, see that QD = QS = 30(000) at a contract price of $25 per hour. Thus,P = $25 per hour and Q = 30(000) is the equilibrium price/output combination.Competitive Market Equilibrium. Happy Valley Supply, Inc., provides recycled tonercartridges for printers. Like its competitors, Happy Valley must meet strict specifications.As a result, the replacement toner cartridge market can be regarded as perfectlycompetitive. Total and marginal cost relations per week are:TC = $4,000 + $5Q + $0.1Q2MC = ∂TC/∂Q = $5 + $0.2Qwhere Q is the number of recycled toner cartridges.
  17. 17. A.Calculate Happy Valleys optimal output and profits if prices are stable at $55 per tonercartridge.B.Calculate Happy Valleys optimal output and profits if prices rise to $65 perunit.C.If Happy Valley is typical of firms in the industry, calculate the firms equilibriumoutput, price, and profit levels.ANS:A.Because the industry is perfectly competitive, P = MR = $55. Set MR = MC to find theprofit-maximizing activity level.MR = MC$55 = $5 + $0.2Q0.2Q = 50Q = 100π = TR -TC = $55(100) - $4,000 - $5(100) - $0.1(1002) = $0B.After a rise in prices to $65, the optimal activity level rises to Q = 120 because:MR =MC$65 = $5 + $0.2Q0.2Q = 60Q = 120π = TR - TC = $65(120) - $4,000 - $5(120) -$0.1(1202) = $1,760C.In equilibrium, P = AC and MR = MC at the point where average cost is minimized. Tofind the point of minimum average costs we set:MC = AC = TC/Q$5 + $0.2Q = ($4,000 +$5Q + $0.1Q2)/Q5 + 0.2Q = + 5 + 0.1Q0.1Q = Q= = 200P = AC = + $5 + $0.1(200) = $45π = TR - TC = $45(200) - $4,000 - $5(200) - $0.1(2002)= $0Competitive Market Equilibrium. Syracuse Paper supplies printer paper in upstate NewYork. Like the output of other wholesale distributors, Syracuse Paper must meet strictguidelines and the printer paper supply industry can be regarded as perfectly competitive.Total and marginal cost relations are:TC = $3,600 + $5Q + $0.01Q2MC = ∂TC/∂Q = $5 + $0.02Qwhere Q is cases of printer paper per day.A.Calculate the firms optimal output and profits if prices are stable at $20 percase.B.Calculate optimal output and profits if prices rise to $25 per case.C.If SyracusePaper is typical of firms in the industry, calculate the firms equilibrium output, price, andprofit levels.ANS:A.Because the industry is perfectly competitive, P = MR = $20. Set MR = MC to find theprofit-maximizing activity level.MR = MC$20 = $5 + $0.02Q0.02Q = 15Q = 750 per dayπ= TR - TC = $20(750) - $3,600 - $5(750) - $0.01(7502) = $2,025B.After a rise in prices to $25, the optimal activity level grows to Q = 1,000 because:MR =MC$25 = $5 + $0.02Q0.02Q = 20Q = 1,000π = TR - TC = $25(1,000) - $3,600 -$5(1,000) - $0.01(1,0002) = $6,400C.In equilibrium, P = AC and MR = MC at the point where average cost is minimized. Tofind the point of minimum average costs set:MC = AC = TC/Q$5 + $0.02Q = ($3,600 +$5Q + $0.01Q2)/Q5 + 0.02Q = + 5 + 0.01Q0.01Q = Q2 = Q=
  18. 18. = 600P = AC = + $5 + $0.01(600) = $17π = TR - TC = $17(600) -$3,600 - $5(600) - $0.01(600 ) = $0 2

×