Perfect Competition Practice

1. Which of the following is a characteristic of perfectly competitive markets?A. restricted entry to new firmsB. homogeneous goodsC. market powerD. slightly differentiated goodsE. firms set the price they charge

Reason: All firms in a perfectly competitive market sell homogeneous goods, meaning that all goods in the market are perfectly identical. For example, if the market for sausage is perfectly competitive, all firms sell sausage that tastes identical to every other firms’ sausage.

2. Which of the following best describes a firm’s demand curve in a perfectly competitive market?A. downward slopingB. straight and horizontalC. upward slopingD. straight and verticalE. downward sloping then upward sloping

Reason: The individual firm’s demand in a perfectly competitive market is horizontal at the market price because it can sell however much it wants at that market price. It doesn’t need to decrease price to increase the quantity demanded of its good.

3. Which of the following best describes the profit-maximizing rule for a perfectly competitive firm?A. Choose the price where its marginal revenue is highest.B. Choose the price where average total cost equals average revenue.C. Choose the quantity where marginal cost equals average total cost.D. Choose the quantity where marginal cost equals price.E. Choose the quantity where marginal revenue equals average total cost.

Reason: The profit-maximizing rule is to produce the quantity where marginal cost equals marginal revenue. For a perfectly competitive firm, its marginal revenue equals the market price.

This graph shows the cost curves and marginal revenue curves for a firm.

4. How much is this firm’s profit?A. -$135,000B. $450,000C. $950,000D. $360,000E. $400,000

Reason: Profit is the profit-maximizing choice of quantity multiplied by the difference between price and average total cost:

Twilly enterprises produces watches in a perfectly competitive market. Its cost and revenue curves are shown in this graph.

5. What quantity will this firm produce, and what price will it charge, in the short run?A. Q=8000, P=$75B. Q=6000, P=$80C. Q=8000, P=$48D. Q=6000, P=$48E. This firm will Shut down

Reason: A profit-maximizing producer chooses the quantity where marginal cost equals marginal revenue. On a graph, this is the quantity where the marginal cost curve intersects the marginal revenue curve, which occurs where quantity equals 6000. This firm has a horizontal marginal revenue curve, indicating it has to take the price of $48, as given.

This graph shows the cost curves and marginal revenue curves for a firm.

6. How much is this firm’s short-run profit?A. $75,000B. -$600,000C. -$284,000D. -$124,000E. 0

Reason: Profit is the rectangle that represents the quantity sold multiplied by the difference between price and average total cost:

This graph illustrates cost and revenue curves for a firm in a perfectly competitive market.

7. What is the quantity that this firm will produce, and what price will it charge?A. Q= 1000; P= $110B. Q= 400; P= $32C. Q= 1000; P= $60D. Q= 600; P= $110E. Q= 600; P= $50

Perfect Competition in the Short Run and Long Run Practice:8. If a firm produces the quantity where the private marginal cost of the last unit produced equals the private marginal benefit of the last good consumed, which of the following must also be true?

A. All firms are making lossesB. All firms are earning a profitC. The firm is cost-efficient.D. The quantity produced is allocatively efficient.E. The market is in long-run equilibrium

Reason: When the marginal cost of the last unit produced equals the marginal benefit of the last unit produced, then the amount produced is allocatively efficient. A perfectly competitive firm produces an allocatively efficient quantity.

9. Eggs are a normal good sold in a perfectly competitive market that is currently in long-run equilibrium. How will price, output, and profit change if consumer incomes increase?

A. price decreases; output increases; profit decreasesB. price increases; no change in output; no change in profitC. price decreases; output decreases; profit increasesD. price increases; output increases; profit increasesE. price increases; no change in output; profit increases.

Reason: The market demand for a normal good increases when income increases which raises the price of eggs. When price increases, a perfectly competitive firm’s marginal revenue increases, so the profit-maximizing level of output increases. An increase in price also increases profit.

This graph shows the average total cost (ATC), marginal cost (MC), and average variable cost (AVC) cost curves for a typical firm in a perfectly competitive market

10. At which price is there no incentive for firms to enter or exit this market?A. P3B. P1C. P2D. P5E. P4

Reason: P2 equals ATC, which means this firm makes no economic profit. When firms make profits, this entices other firms to enter this industry in the long run.

11. Fried Breads Revisited is a food truck in a perfectly competitive industry. Its total cost of producing 100 donuts is $300 and the market price for a donut is $4.If this firm is representative of a typical firm in the market, which of the following can be inferred?

A. The marginal cost of the 100th unit is greater than $4.B. Firms will enter this market in the long run.C. There is no incentive for firms to enter or exit this market.D. This firm is earning economic loss.E. This firm should lower its price to increase its sales.

Reason:This firm is earning a profit because its average total cost is $3 and its price is $4.When firms are earning profits, they are operating on the increasing portion of their average total cost curve. Also, when firms earn profits, this attracts other firms into the industry.

12. If a firm in a perfectly competitive market chooses its profit-maximizing quantity, which of the following MUST be true?

A. MR> MCB. P= MCC. MC> ATCD. MR<PE. P> ATC

Reason:A profit-maximizing firm in a competitive market chooses the quantity where marginal revenue equals marginal cost (MC). A perfectly competitive firm’s marginal revenue equals the market price, so the price must also equal MC.

13. Which of the following is true if typical firms in a perfectly competitive market are allocatively efficient and produce at the lowest possible cost per unit?

A. Firms are making economic losses and more firms will exit this industry.B. Firms will decrease their average total costs if they increase outputC. The market is in long-run equilibrium.D. The market supply will shift rightE. Firms are earning economic profits and more firms will enter this industry.

Reason: Allocative efficiency occurs when a firm produces the quantity where marginal cost equals marginal revenue, and firms in perfectly competitive markets are always allocatively efficient. When perfectly competitive firms produce at the lowest possible cost per unit, which is sometimes called productive efficiency, they are earning zero economic profits and no other firms have an incentive to enter or exit this market, which occurs in long-run equilibrium.

14. Which of following best describes a perfectly competitive firm in the short run and the long run?A. Short run: productively efficient only; long run: allocatively efficient onlyB. Short run: neither allocatively efficient nor productively efficient; long run: neither allocatively efficient nor

productively efficientC. Short run: allocatively efficient; long run: allocatively efficient and productively efficientD. Short run: allocatively efficient and productively efficient; long run: neither allocatively efficient nor productively

efficientE. Short run: neither allocatively efficient nor productively efficient; long run: allocatively efficient and productively

efficient

Reason: Allocative efficiency occurs when a firm produces the quantity where marginal benefit (MB) equals marginal cost (MC). A perfectly competitive firm always produces the allocatively efficient quantity because the good’s price reflects its marginal benefit, and a perfectly competitive firm always produces where P=MR=MC. Productive efficiency occurs when a firm produces the quantity where average total cost is minimized, and a perfectly competitive firm produces this quantity in the long run.

The market for happy face stickers is perfectly competitive, and the market price for these stickers is greater than the average total cost (ATC) of a typical firm.

15. Which of the following is true about this market?

A. Firms are earning positive economic profits and more firms will enter this industry.B. Firms are producing an allocatively inefficient quantity and firms will exit this industry.C. Firms are charging prices higher than the marginal cost of producing stickers.D. Firms are producing a cost-efficient quantityE. Firms are earning zero economic profits and the market is in long-run equilibrium

Reason: Economic profit is positive when the price is greater than ATC, and firms enter an industry with free entry and exit when there are economic profits.

Firms Short Run Decisions to Produce and Long-Run Decisions to Enter or Exit the Market.

Bailey runs a water sports service in a perfectly competitive beach town. The price she is able to charge for her services varies from day to day, but she has no control over that price. Her cost and revenue curves for a perfectly competitive industry are shown in this graph:

16. What is the lowest price at which Bailey would be willing to produce in the short run?

A. $55B. $140C. $40D. $147E. $90

Reason: Anka is willing to produce as long as she can get a price higher than the minimum average variable cost (AVC). The lowest point on her AVC is at $55so any price less than $55 will make her shut down.

Khan is a consultant for an economic advisory service. He currently produces 10 hours per week of consultancy services. The price of an hour of his services is $60 and the market for consultancy services is perfectly competitive. The table below shows his costs associated with producing 10hours of services:

17. If Khan wants to maximize profit, what is his best course of action in the short run?

A. exit the industryB. decrease outputC. do not change outputD. shut downE. increase output

Reason: The optimal quantity to produce is the quantity where the marginal cost of that quantity equals the marginal revenue of that quantity. At a constant price of $60per hour, the marginal revenue is also $60per hour, and the marginal cost of producing 10 hours is also $60.

The cost and marginal revenue curves for a firm in a perfectly competitive market are shown in this graph.

18. What price will convince other firms to enter this industry?A. $214B. $20C. $130D. $35E. $80

Reason: At this price this firm earns an economic profit because price is greater than average total cost. When firms earn economic profits, this entices other firms to enter the industry.

19. Which of the following best describes the shutdown rule?

A. Exit the industry when P < Average variable costB. Chose the Q where MC (Q) = MR (Q) if P > ATCC. Chose Q = 0 when P > Average variable costD. Chose Q = 0 when P < Average variable costE. Exit the industry when P < Average total cost

Reason: When a firm cannot even cover its variable cost, its best response is to shut its doors in the short run.

The cost and revenue curves for a perfectly competitive industry are shown in this graph:

20. What best describes how a firm would respond in the short-run?

A. Shut downB. Charge a higher priceC. Increase output to decrease average total costD. Increase output to increase revenueE. Exit the industry

Reason: The shut down rule says that a firm will not produce anything, or shut down, when price is less than average variable cost. In this situation, a firm cannot even cover its variable costs of producing, so its best choice is to not produce at all in the short run.