Chapter 6 Competitive Markets

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1 Chapter 6 Competitive Markets Multiple Choice Questions Choose the one alternative that best completes the statement or answers the question. 1. If a firm is producing 12 pairs of skates at a price of \$120, an average total cost of \$110, and an average variable cost of \$90, which of the following is true? (a) TC = \$1,080. (b) TC = \$1,440. (c) The firm is in long-run equilibrium. (d) Profit = \$120. (e) Profit = \$ If a firm is producing 12 pairs of skates at a price of \$120, an average total cost of \$110, and an average variable cost of \$90, which of the following is true? (a) TC = \$1,080. (b) TC = \$1,440. (c) TC = \$1,320. (d) The firm is in long-run equilibrium. (e) Profit = \$ If a firm is producing 12 pairs of skates at a price of \$120, an average total cost of \$110, and an average variable cost of \$90, which of the following is true? (a) In the long-run firms will enter. (b) In the short-run firms will exit. (c) The firm is in long-run equilibrium. (d) In the short-run firms will enter. (e) The firm is making a profit equal to \$360.

2 Chapter 6 Competitive Markets If a firm is producing 9 pairs of skates at a price of \$100, an average total cost of \$110, and an average variable cost of \$90, which of the following is true? (a) TC = \$990. (b) TC = \$900. (c) The firm is in long-run equilibrium. (d) The firm is making a profit of \$90. (e) The firm should shut down. 5. If a firm is producing 9 pairs of skates at a price of \$100, an average total cost of \$110, and an average variable cost of \$90, which of the following is true? (a) TC = \$900. (b) TC = \$810. (c) The firm is in long-run equilibrium. (d) The firm is making a loss of \$90. (e) The firm should shut down. 6. If a firm is producing 9 pairs of skates at a price of \$100, an average total cost of \$110, and an average variable cost of \$90, which of the following is true? (a) In the long-run firms will enter. (b) In the long-run firms will exit. (c) The firm is in long-run equilibrium. (d) In the short-run firms will enter. (e) The firm is making a profit loss to \$ In perfectly competitive markets, the market demand curve is (a) perfectly elastic. (b) a horizontal line at the market price. (c) perfectly inelastic. (d) negatively sloped. (e) positively sloped. 8. In a perfectly competitive market, an increase in the market demand curve (a) will cause economic dislocation to all firms. (b) will cause the market supply curve to decrease in the short-run. (c) will cause the market supply curve to increase in the short-run. (d) will decrease the price to all firms in the industry.

3 62 Gregory Essentials of Economics, Sixth Edition 9. What prevents a single perfectly competitive firm from supplying the entire market? (a) The price of the product. (b) The market demand curve. (c) The market supply curve. (d) Costs. 10. One-hour photo processing is an excellent example of (a) too many firms in an industry in the early 1980s. (b) firms always producing at zero economic profit. (c) minimal barriers to entry. (d) huge firms being able to dominate the industry. 11. The demand curve for a monopolistically competitive firm is (a) perfectly elastic. (b) a horizontal line at the market price. (c) perfectly inelastic. (d) negatively sloped. (e) positively sloped. 12. Monopolistically competitive firms do not have the characteristic of (a) free entry and exit. (b) zero economic profits in the long-run. (c) operating at minimum average total cost in the long-run. (d) many buyers and sellers. 13. Monopolistically competitive firms make life interesting because (a) the firms always earn positive economic profits. (b) the firms increase the variety of products. (c) the firms are more efficient than perfectly competitive firms. (d) the firms operate at the monopoly price. 14. In the very long run, monopolistically competitive markets operate like (a) perfectly competitive firms and face, for all practical purposes, a horizontal demand curve. (b) a monopoly and charge a high price for the differentiated product. (c) a monopoly and make higher profits than perfectly competitive firms. (d) oligopolistic markets by colluding and charging the monopoly price.

4 Chapter 6 Competitive Markets Price-taking behavior occurs when (a) P = MR. (b) the firm can sell all it wants at the market price. (c) the firm faces so much competition it cannot control price. (d) there are a large number of sellers. 16. In the short run, the profit-maximizing rules are (a) P = minimum average cost and ATC = AVC. (b) P = ATC and AVC = MC. (c) P > ATC and P = MC. (d) P > AVC and P = MC. (e) P = AVC and P = MC. 17. The long-run result of producing where P = MC in an industry where there is free entry or exit is (a) inefficient production. (b) positive economic profit. (c) negative economic profit. (d) zero economic profit. (e) the firm shuts down. 18. In a perfectly competitive industry the fact that a typical firm s product price is less than its average total cost (a) is a signal for resources to eventually leave the industry. (b) means firms will shut down in the short run. (c) means firms are not producing where P = MC. (d) cannot be true in the short run. 19. While the exit of firms from declining sectors of the economy generates job losses, an important lesson of the theory of competition is that (a) competition provides important patents and innovation for new products. (b) economies of scale are the norm in competitive industries. (c) firms typically earn positive economic rents from producing in competitive markets. (d) resources leaving declining sectors of the economy find employment in expanding markets. (e) producer surplus a is good measure of the losses to society from declining industries.

5 64 Gregory Essentials of Economics, Sixth Edition 20. Assume that in a perfectly competitive industry that consists of 2,000 firms, each firm is making an economic profit of \$10,000 per year. Which of the following predictions about this industry is likely to come true? (a) In the long run, the industry will consist of less than 2,000 firms. (b) In the long run, economic profits will continue. (c) In the long run, the price of this product will equal the minimum average cost of production. (d) In the long run, the price of this product will be less than the minimum average variable cost of production. 21. The characteristics of a perfectly competitive industry are (a) price taking, homogeneous products, and significant barriers to entry. (b) advertising and economies of scale. (c) price taking, homogeneous products, and ease of entry. (d) diseconomies of scale and high average fixed costs. (e) high fixed costs and low variable costs. 22. If a producing firm is able to quintuple its current level of production and still sell its output at the same price, the producer is (a) a price searcher. (b) a monopolist. (c) producing with rising average cost. (d) a single proprietorship. (e) a price taker. 23. It pays any firm to stay in business in the short run if (a) P exceeds AFC. (b) P is less than MC. (c) P is less than AVC. (d) P is less than ATC. (e) P exceeds AVC. 24. If the lowest average variable cost of a firm is \$18 and the market price is \$15, the firm should (a) shut down. (b) produce between 5 and 10 units of output. (c) make a profit. (d) produce, even if it is losing money. (e) produce, as long as marginal cost is less than \$15.

6 Chapter 6 Competitive Markets Which of the following is correct? A perfectly competitive firm (a) sets MR greater than MC. (b) sets P greater than MC. (c) does not produce if P is less than AVC. (d) will not produce if all variable costs and some fixed costs are covered. 26. In the long run, competitive firms produce at minimum average cost because (a) they wish to serve society. (b) only if firms produce a minimum average cost can they maximize profit. (c) the mechanism of free entry and exit brings it about. (d) supply and demand always intersect at that price. 27. In the short run, the least important characteristic of perfect competition is (a) a large number of sellers and buyers. (b) a homogeneous product. (c) that buyers and sellers have perfect information regarding prices and quality. (d) that each seller is a price taker. (e) freedom of entry into and exit from the industry. 28. If a firm can sell all the output it wants at a price of \$5 per unit, the firm s (a) marginal revenue equals \$5. (b) marginal revenue can be negative at high levels of output. (c) marginal revenue exceeds \$5. (d) total revenue is \$5. (e) total revenue is constant as output rises. 29. The supply curve for a firm in perfect competition in the short run (a) depends on the industry s supply curve. (b) depends on the industry s demand curve. (c) is the average-total-cost curve. (d) is the marginal-cost curve above minimum average variable cost. (e) is the average variable cost curve. 30. When the price of a competitive industry s product increases, producer surplus (a) can decrease. (b) must increase. (c) increases if demand is inelastic. (d) decreases if demand is elastic. (e) increases if supply is price elastic.

7 66 Gregory Essentials of Economics, Sixth Edition 31. In a competitive industry, a reduction in demand (a) will increase the price of the product because of economies of scale. (b) will reduce the price of the product. (c) will create positive economic profits. (d) cannot lower price in the short run but must in the long run. (e) will raise price in the short run. 32. Which of the following is correct? In a perfectly competitive industry with free entry, (a) the number of firms is fixed in the long run. (b) if P > AVC, the number of firms will increase. (c) if P > ATC, the number of firms will increase. (d) if P < ATC, the number of firms will increase. (e) if P > MC, the number of firms will increase. 33. Which of the following is a characteristic of perfect competition? (a) Each seller is a price taker. (b) Firms produce a homogeneous product. (c) There is freedom of entry into and exit from the industry. (d) Each buyer and seller has perfect information about prices and product quality. 34. According to the shutdown rule in perfect competition, (a) if fixed costs are greater than variable costs for all levels of output, then the firm should shut down. (b) if profits are negative, then the firm should shut down. (c) if revenues are less than variable costs at all levels of output, then the firm should shut down. (d) if the firm can t cover its fixed costs, it should shut down. (e) if the firm can t cover its average total costs, it should shut down. 35. An important difference between perfect competition and monopolistic competition is that (a) in monopolistic competition prices do not influence quantity demanded. (b) in perfect competition all economic agents are price searchers. (c) there is no competition under monopolistic competition. (d) one produces a homogeneous product and the other produces a differentiated product. (e) entry is free in competition but impossible in monopolistic competition.

8 Chapter 6 Competitive Markets Which of the following is correct? For the perfectly competitive firm, (a) price is greater than marginal revenue. (b) price equals total cost. (c) price is less than marginal revenue. (d) profits will be maximized when price equals total cost. 37. A perfectly competitive firm should produce at that quantity where price equals marginal cost unless (a) revenues are less than variable costs at all levels of output. (b) it is running a loss at that quantity. (c) anticipates entry by new firms. (d) the demand curve is perfectly elastic at the going market price. (e) it is earning economic profits. 38. As new firms enter a perfectly competitive market that is experiencing short-run positive economic profits, (a) the demand curve will move up the supply curve, and prices will increase. (b) the demand curve will move down the supply curve, and prices will fall. (c) the supply curve will move to the right. (d) the supply curve will move to the left. (e) other firms will exit to maintain the equilibrium number of firms. 39. In a perfectly competitive industry in the long run, if price fails to cover average costs, (a) prices will eventually fall. (b) firms will enter the industry. (c) the market supply curve will shift to the left. (d) the market demand curve will shift to the right. 40. Which of the following is correct? Increasing international trade has (a) increased the relevance of the competitive model as a tool for explaining market behavior. (b) had little impact on competition in U.S. markets. (c) increased the relevance of the monopoly model as a tool for explaining market behavior. (d) had little impact on competition in international markets. (e) None of the above is true.

9 68 Gregory Essentials of Economics, Sixth Edition 41. A firm operating in a competitive industry (a) will not experience diminishing returns in the short run. (b) cannot exit the industry in the long run. (c) should shut down if P > AVC. (d) has no control over market price. (e) should produce only if economic profits are positive. 42. Suppose the pizza industry in the city where you are attending college approximates the conditions of a competitive industry. If a normal profit is 10%, a rate of return exceeding 10% would (a) cause an increase in pizza prices. (b) imply firms are experiencing economies of scale. (c) suggest that firms are operating at minimum LRAC. (d) mean that firms are earning zero economic profit. (e) attract new firms to the industry. 43. We would expect that free entry and exit in wheat production would ensure (a) zero accounting profits. (b) positive economic profits. (c) price greater than marginal cost. (d) zero economic profit. (e) negative accounting profits. 44. Which of the following is always correct? For a perfectly competitive firm producing a profitmaximizing output, (a) total revenues equal total costs. (b) marginal cost equals average cost. (c) price equals average variable cost. (d) marginal revenue equals price. 45. For a perfectly competitive firm, the price elasticity of demand for the firm s demand curve is (a) infinite. (b) less than 1. (c) equal to 1. (d) 0. (e) greater than 1.

10 Chapter 6 Competitive Markets Which of the following is correct? For a competitive industry, (a) the market demand is horizontal but the firm s demand curve is downward-sloped. (b) the market demand curve is downward-sloped but the firm s demand curve is horizontal. (c) the market and the individual firm s demand curves are horizontal. (d) the market and the individual firm s demand curves are downward-sloped. 47. We would expect that free entry and exit in wheat production would (in the long run) ensure (a) total revenues would equal all economic costs. (b) marginal costs less than average costs. (c) economic losses since quantity supplied exceeds quantity demanded. (d) price equals average variable costs. (e) positive economic profits necessary to cover the opportunity cost of capital. 48. Which of the following is correct? In a competitive industry with economic losses, (a) accounting profits are negative. (b) industry supply shifts to the left due to the exit of firms and losses are reduced. (c) entry by consumers wishing to take advantage of bargain-basement prices eliminates losses. (d) accounting profits are positive. (e) LRAC = MC. 49. A competitive firm that has zero economic profit will have a rate of return that of comparable industries. (a) much greater than (b) greater than (c) less than (d) equal to (e) that is indeterminate relative to 50. Which of the following statements is correct for a profit-maximizing firm? (a) If MR > MC, the firm should decrease output since additional revenues exceed additional costs. (b) If MR < MC, the firm should decrease output since additional revenues are less than additional costs. (c) If MR > MC, the firm should increase output since additional revenues are less than additional costs. (d) If MR < MC, the firm should increase output since additional revenues are less than additional costs.

11 70 Gregory Essentials of Economics, Sixth Edition 51. In the short run, a profit-maximizing competitive firm should produce, even if it is losing money, if P > AVC. This decision-rule works because (a) the firm can cover all of its fixed costs and pay part of its variable costs, resulting in a smaller loss than if it doesn t produce. (b) the firm can cover all of its variable costs and pay part of its fixed costs, resulting in a smaller loss than if it doesn t produce. (c) the firm can cover all of its fixed costs and pay part of its variable costs, resulting in a larger loss than if it doesn t produce. (d) the firm can cover all of its variable costs and pay part of its fixed costs, resulting in a larger loss than if it doesn t produce. (e) the firm can cover all of its marginal costs and variable costs, resulting in a larger loss than if it doesn t produce. Figure Assuming that each graph in Figure 6.1 represents a loss-minimizing competitive firm in the shortrun, at the loss-minimizing output for each firm, which of the following is correct? (q* is the output at which MR = MC) (a) The shaded area for Firm A correctly illustrates the firm s loss, while the shaded area for Firm B incorrectly illustrates the firm s loss. (b) The shaded area for Firms A and B correctly illustrates the firm s loss. (c) The shaded area for Firms A and B incorrectly illustrates the firm s loss. (d) The shaded area for Firm A incorrectly illustrates the firm s loss, while the shaded area for Firm B correctly illustrates the firm s loss. 53. In Figure 6.1, (a) Firm A is making a short-run loss. (b) Firm B is making a short run loss. (c) Firm A is making a short-run profit. (d) Firm B is making a short run profit.

12 Chapter 6 Competitive Markets 71 Figure Assuming that each graph in Figure 6.2 above represents a loss-minimizing competitive firm in the short-run, at the loss-minimizing output for each firm, which of the following is correct? (q* is the output at which MR = MC) (a) The shaded area for Firm A correctly illustrates the firm s loss, while the shaded area for Firm B incorrectly illustrates the firm s loss. (b) The shaded area for Firms A and B correctly illustrates each firm s loss. (c) The shaded area for Firms A and B incorrectly illustrates each firm s loss. (d) The shaded area for Firm A incorrectly illustrates the firm s loss, while the shaded area for Firm B correctly illustrates the firm s loss. 55. In Figure 6.2, (a) Firm A is making a short-run loss. (b) Firm B is making a short run loss. (c) Firm A is making a short-run profit. (d) Firm B is making a short run profit.

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