1 Exercises on Perfect Competition 1) When a firm has no ability to influence market prices it is said to be in what kind of a market? 2) In a competitive market, how will the actions of any single buyer or seller impact the market price? 3) a) List and describe the characteristics of a perfectly competitive market. b) Why would a firm in a perfectly competitive market always choose to set its price equal to the current market price? If a firm set its price below the current market price, what effect would this have on the market? 4) Manger of firm X, reports that he faces the following price and quantity relationship for his product: Quantity (q) Price (P) a) The price and quantity relationship in the table above is most likely that faced by a firm in what type of market structure? b) Over which range of output is marginal revenue equal to price? c) Over what range of output is marginal revenue declining? d) For a firm, like firm X in a perfectly competitive market, what type of relationship is there between the price of the good and marginal revenue? e) Manager of firm X is debating whether he should decrease his price below $13 to sell more units. Please advise. f) In class we said that the firms like firm X in perfect competition are price takers, it implies that if firm X raises its price, what will happen? g) If firm X in a competitive market reports to have zero economic profit, what can you infer about its accounting profit? 5) As a general rule, when accountants calculate profit they account for explicit costs but usually ignore which type of costs?
2 6) As part of an estate settlement Mary received $1 million. he decided to use the money to purchase a small business in elaware, Ohio. If Mary would have invested the $1 million in a risk-free bond she could have made $, each year. he also quit her job at Honda to devote all of her time to her new business; her salary at Honda was $75, per year. At the end of the first year of operating her new business, Mary s accountant reported an accounting profit of $1,. a) What was Mary s economic profit? b) What are Mary s opportunity costs of operating her new business? 7) a) What is the formula to calculate total profit for a firm? b) Can you express the total profit formula in terms of per unit profit? c) What is the rule for profit maximization? 8) The Wheeler Wheat Farm, which operates in a competitive market, sells wheat to a grain broker in eattle, Washington. The Wheeler Wheat Farm reports the following data: Quantity (q) Total Revenue Total Cost $ $ a) At which quantity of output is marginal revenue equal to marginal cost? b) uppose in the wheat industry, a change in demand results the wheat prices to rise to $11. What should the wheat farm do to maximize its profit? c) uppose a decrease in demand caused wheat prices to drop to $5 in the industry. What should the wheat farm do to maximize its profit? d) Wheeler farm s manager tells you that the total revenue is less than variable costs at their profit maximizing output. What would you advise? e) The Roadrunner farm, Wheeler s one of competitors, reports that at their profit maximizing output, the price is below average variable cost. What would you advise? f) When would a profit-maximizing firm shut down in the short run? (Write your expression in terms of one unit of output) g) When would a profit-maximizing firm shut down in the short run? (Write your expression in terms of q units of output)
3 h) escribe how we can identify a competitive firm s short-run supply curve. 9) a) In the long run all of a firm s costs are variable. In this case, what is the exit criterion for a profit-maximizing firm? b) When profit-maximizing firms in competitive markets are earning profits, in the long run what would happen? c) You witnessed new firms entering a competitive market. What can you infer for the existing firms in that market? d) In doorknob manufacturing industry, you observed that the firms are making losses. In the long run what would happen? e) You observed that in the long run, a profit-maximizing firm chose to exit a market. What can you infer about the profits of this firm? f) What signals the firms to enter or exit a market in a competitive industry? g) You observed that firms are neither entering nor exiting the competitive industry where soybeans are produced. List all that you can infer about existing firms data from this observation. ) A firm in a competitive market has the following cost structure: Output Total Cost $5 1 $ 2 $12 3 $15 4 $24 5 $ a) If the market price is $3, what will this firm do in the short run? b) If the market price is $3, what will this firm do in the long run? c) If the market price is $9, what will this firm do in the short run?
4 11) In each of the diagrams below the figure on the right represents the perfectly competitive milk industry. The one on the left represents an individual milk producer in this market. In all diagrams the vertical axis is measured in dollars, and the horizontal axis represents output. The diagrams are labeled A, B and C. Match the letter of the graph to the correct scenario given below. A 5 15 B 5 15 C 5 15 The industry supply will decrease and firms will exit the industry in diagram since individual firms are making negative economic profit. The industry supply will increase and new firms will enter the industry in diagram since individual firms are making positive economic profit. The market in diagram is in the LR equilibrium since individual firms are making zero economic profit.
5 12) queaky-clean is a car wash company operating in a perfectly competitive market in the short run. The total cost of providing car wash service for various output levels is given below. Moreover, the queaky-clean s fixed costs (FC) are given as $. Output (Q) Total Cost (TC) If the price of a car wash is determined in the industry as $8, how many cars will be washed by queaky-clean in the short run? What is the total profit of this firm? 13) The short Run Cost Curves for a firm operating in a perfectly competitive market are given below. P($) ATC a) If the market price is $7 in the perfectly competitive industry, in the short run how many units will this firm produce? How much profit will it make? b) escribe the supply curve of the above firm. c) Give an example of a price where this firm makes positive economic profit? d) Give an example of a price where this firm makes negative economic profit? e) Can you calculate the FC of the above firm from the cost curves drawn above? AVC Q
6 14) a) escribe the changes that would take place in the long run in a competitive market where firms are earning economic profits in the short run. b) escribe the changes that would take place in the long run in a competitive market where firms are making negative profits in the short run. 15) The residential gutter cleaning industry comprises of many identical firms offering the same service in Columbus. The diagram on the right represents the perfectly competitive gutter cleaning industry. The long run costs of We Gut Gutters, a representative firm in the industry, are shown in the left-hand panel a) Given the data above, what is the current market price for gutter cleaning? b) Given the current market price, determine how many gutter cleaning services will We Gut Gutters provide in the short run if it wants to maximize profit? c) At the current market price what is the total industry output? d) How many firms are currently operating in the industry? e) Is the gutter cleaning industry currently in long run equilibrium? If not, will the firms enter or exit the industry? f) What will be the equilibrium price of a gutter cleaning service in the long run? g) In the long run, how many gutter cleaning services will We Gut Gutters provide? h) How many firms will operate in the industry in the long run equilibrium?