CH. 12 Study Guide

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Q1. What conditions make a market perfectly competitive?

Background

Topic: Perfect Competition

This question tests your understanding of the defining characteristics of a perfectly competitive market structure in microeconomics.

Key Terms:

Perfect Competition: A market structure with many buyers and sellers, identical products, and no barriers to entry.
Barriers to Entry: Obstacles that make it difficult for new firms to enter a market.

Step-by-Step Guidance

Review the definition of perfect competition. Focus on the number of buyers and sellers, product differentiation, and entry barriers.
Compare each answer choice to the definition. Eliminate options that mention a single firm, differentiated products, or barriers to entry.
Identify the option that matches all three criteria: many buyers and sellers, identical products, and no barriers to entry.

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Q2. Fill in total revenue, average revenue, and marginal revenue for Farmer Jones (perfect competition, $14 per crate).

Background

Topic: Revenue Calculations in Perfect Competition

This question tests your ability to calculate total revenue (TR), average revenue (AR), and marginal revenue (MR) for a perfectly competitive firm.

Key Formulas:

Step-by-Step Guidance

For each quantity, multiply the market price by the number of crates to find TR.
Divide TR by the number of crates to find AR for each level (except when quantity is zero).
Calculate MR by finding the change in TR as you increase output by one crate.
Notice that in perfect competition, AR and MR should equal the market price.

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Q3. At what market price will Farmer Jones earn a profit? (Given ATC and MC curves)

Background

Topic: Profit and Cost Curves in Perfect Competition

This question tests your understanding of when a firm earns positive economic profit based on cost curves and market price.

Key Concepts:

Average Total Cost (ATC): Total cost divided by output.
Profit: Occurs when price > ATC at the profit-maximizing output.

Step-by-Step Guidance

Identify the minimum point of the ATC curve on the graph.
Recall that profit is earned when the market price is above ATC at the output where MC = MR (in perfect competition, MR = price).
Find the price level just above the minimum ATC.

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Q4. If Farmer Jones produces the profit-maximizing quantity at a market price of $26 per box, what is her profit?

Background

Topic: Profit Maximization in Perfect Competition

This question tests your ability to determine profit at a given market price using cost curves.

Key Formulas:

Find the output where

Step-by-Step Guidance

Locate the output where the MC curve intersects the market price ($26).
At this output, find the corresponding ATC from the graph.
Subtract ATC from the market price to get per-unit profit.
Multiply per-unit profit by the quantity produced to find total profit.

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Q5. What is the firm's profit when it produces optimally in the short run? (Shade the profit area on the graph)

Background

Topic: Short-Run Profit in Perfect Competition

This question tests your ability to identify profit on a cost curve diagram for a perfectly competitive firm.

Key Concepts:

Profit Area: The rectangle between price and ATC at the profit-maximizing output.
Profit-Maximizing Output: Where (in perfect competition, ).

Step-by-Step Guidance

Find the output where the MC curve intersects the market price (demand curve).
At this output, identify the ATC.
The profit per unit is the vertical distance between price and ATC at this output.
The total profit is the area of the rectangle: (Price - ATC) × Quantity.

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Q6. If the market price is $22 per unit, characterize the firm's profit and decide whether to shut down in the short run.

Background

Topic: Short-Run Decisions – Losses and Shutdown

This question tests your understanding of when a firm should continue to produce or shut down in the short run based on price, average variable cost (AVC), and average total cost (ATC).

Key Concepts:

Shutdown Rule: In the short run, a firm should continue to produce if price ≥ AVC, even if it is making a loss (price < ATC).
Losses: Occur when price < ATC.

Step-by-Step Guidance

Compare the market price ($22) to the firm's AVC and ATC at the profit-maximizing output.
If price > AVC but < ATC, the firm should produce and incur a loss.
If price < AVC, the firm should shut down immediately.
Choose the correct answer based on these comparisons.

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Q7. What is the economic profit for the assistant professor who opens a bookstore?

Background

Topic: Economic vs. Accounting Profit

This question tests your ability to distinguish between accounting profit and economic profit, considering both explicit and implicit costs.

Key Formulas:

Implicit costs include foregone salary and interest income.

Step-by-Step Guidance

Identify the accounting profit from the tax return.
Calculate the implicit costs: foregone salary and foregone interest from the CD.
Subtract the total implicit costs from the accounting profit to find economic profit.

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Q8. What will likely happen to Xavier's profits in the long run?

Background

Topic: Long-Run Equilibrium in Perfect Competition

This question tests your understanding of how economic profits attract entry and affect long-run equilibrium in a perfectly competitive industry.

Key Concepts:

Economic Profit: Attracts new firms, increasing supply and driving profits to zero in the long run.
Long-Run Equilibrium: Firms earn zero economic profit (break even).

Step-by-Step Guidance

Determine if Xavier is earning an economic profit, breaking even, or incurring a loss.
Recall that in the long run, entry or exit of firms will drive economic profit to zero.
Choose the answer that reflects this adjustment process.

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Q9. What is the economic and accounting profit for the Georgia peach farmer?

Background

Topic: Economic vs. Accounting Profit

This question tests your ability to calculate both accounting and economic profit, including explicit and implicit costs.

Key Formulas:

Implicit costs: foregone interest and foregone salary.

Step-by-Step Guidance

Calculate total revenue: number of baskets × price per basket.
Sum explicit costs: equipment rental and wages.
Find accounting profit by subtracting explicit costs from total revenue.
Calculate implicit costs: interest on savings and foregone salary.
Subtract implicit costs from accounting profit to get economic profit.

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Q10. How many firms are there initially, and what happens in the long run in a perfectly competitive industry?

Background

Topic: Entry and Exit in Perfect Competition

This question tests your understanding of how the number of firms in an industry changes in response to economic profits or losses.

Key Concepts:

Entry: Occurs when firms are earning economic profit.
Exit: Occurs when firms are incurring losses.
Long-Run Equilibrium: Number of firms adjusts so that all firms earn zero economic profit.

Step-by-Step Guidance

Identify the initial number of firms from the data or graph.
Determine if firms are earning profit or loss at the current equilibrium.
Predict whether entry or exit will occur in the long run.
Calculate the new number of firms at long-run equilibrium based on the adjustment process.

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Q11. What happens to apple orchards and housing prices if a new diet increases apple demand?

Background

Topic: Resource Allocation and Market Adjustment

This question tests your understanding of how increased demand for a product affects resource allocation and related markets.

Key Concepts:

Derived Demand: Increased demand for apples increases demand for land for orchards.
Opportunity Cost: Land used for orchards is not available for housing, affecting housing prices.

Step-by-Step Guidance

Consider how a surge in apple demand affects the profitability of apple farming.
Predict how this will influence the number of orchards (resource allocation).
Think about the effect on the supply of land for housing and the resulting impact on housing prices.

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Q12. Why couldn't Sony raise prices to earn a profit despite strong demand for TVs?

Background

Topic: Market Structure and Pricing Power

This question tests your understanding of why firms in competitive markets may not be able to raise prices, even with strong demand.

Key Concepts:

Perfect Competition: Firms are price takers; they cannot set prices above the market equilibrium.
Market Equilibrium: Price is determined by the intersection of supply and demand.

Step-by-Step Guidance

Recall that in competitive markets, individual firms have no control over price.
Consider how an increase in demand affects the market price and quantity in the short and long run.
Think about the role of supply and entry of new firms in adjusting the market price.

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Q13. For each situation, should the firm produce or shut down in the short run?

Background

Topic: Short-Run Production Decisions

This question tests your ability to apply the shutdown rule based on price, variable cost, and fixed cost.

Key Concepts:

Shutdown Rule: Produce if price ≥ AVC; shut down if price < AVC.
Economic Loss: Occurs if price < ATC, but the firm may still produce if price ≥ AVC.

Step-by-Step Guidance

For each situation, calculate average variable cost (AVC = variable cost / quantity).
Compare the market price to AVC and ATC.
Decide whether the firm should produce (if price ≥ AVC) or shut down (if price < AVC).

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Q14. Fill in the missing values for AFC, AVC, ATC, and MC for hiking boots; determine optimal output and profit at different prices.

Background

Topic: Cost Calculations and Profit Maximization

This question tests your ability to calculate average fixed cost (AFC), average variable cost (AVC), average total cost (ATC), and marginal cost (MC), and to use these to determine profit-maximizing output.

Key Formulas:

Profit-maximizing output: where

Step-by-Step Guidance

Calculate AFC, AVC, ATC, and MC for each output level using the formulas above.
For each given price, find the output where price equals MC (or just below, if MC jumps above price).
Calculate profit at that output: .
Repeat for each price scenario.

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Q15. What is the long-run equilibrium price and profit for corn farmers?

Background

Topic: Long-Run Equilibrium in Perfect Competition

This question tests your understanding of how long-run equilibrium is achieved and how profit is determined at that point.

Key Concepts:

Long-Run Equilibrium: Occurs where price equals minimum ATC and firms earn zero economic profit.
Profit Calculation:

Step-by-Step Guidance

Identify the minimum point of the ATC curve on the graph.
Find the price at this point (long-run equilibrium price).
Calculate profit at the given output and price using the profit formula.
Determine the output level where ATC is minimized (break-even point).

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Q16. For Farmer Parker, what is the profit-maximizing output, and how does an increase in marginal cost affect it?

Background

Topic: Marginal Analysis and Profit Maximization

This question tests your ability to use marginal revenue and marginal cost to determine the profit-maximizing output, and to analyze the effect of a change in marginal cost.

Key Concepts:

Profit Maximization: Occurs where
Effect of Cost Changes: An increase in MC may change the output where MR = MC.

Step-by-Step Guidance

For each output level, compare MR and MC to find where MR = MC.
Check if increasing MC by changes the output where MR = MC.
Calculate profit at the new output level if MC increases.

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Q17. How many pumpkins should Isabella grow, and how would you characterize her profit?

Background

Topic: Short-Run Production and Profit Analysis

This question tests your ability to determine optimal output and profit sign (positive or negative) using cost curves and market price.

Key Concepts:

Profit Maximization: Produce where
Profit Sign: Compare price to ATC at the optimal output.

Step-by-Step Guidance

Find the output where the MC curve intersects the market price ().
At this output, compare the price to ATC to determine if profit is positive or negative.
If price < ATC, profit is negative; if price > ATC, profit is positive.