Ghulam Hassan



Chapter 9Pure CompetitionIn a purely competitive industry a large number of firms produce a standardized product and there are no significant barriers to entry.The demand seen by a purely competitive firm in perfectly elastic (horizontal on a graph) at a market price.Marginal revenue and average revenue for a purely competitive firm coincide with the firm’s demand curve; total revenue rises by the product price for each additional unit sold.Profit is maximized, or loss maximized, at the output which marginal revenue (or price in pure competition) equals marginal cost, provided that price exceeds average variable cost.If the market price is below the minimum average variable cost, the firm will minimize its losses by shutting down.The segment of the firm’s marginal-cost curve that lies above the average-variable-cost curve is its short-run supply curve.This Table summarizes the MC=MR approach to determining the competitive firm’s-profit-maximizing output. It also shows the equivalent analysis in terms of total revenue and total cost. Under competition, equilibrium price is given to the individual firm and simultaneously is the result of the production (supply) decision of all as a group.In the long run, the entry of a firm into an industry will compete away any economics profits, and the exit of firms will eliminate losses, so price and minimum average total costs are equal.The long run supply curves of constant-increasing and decreasing-cost industries are horizontal, up-sloping and down-sloping respectively.In pure competitive market, both productive efficiency (price equal minimum average total cost) and allocative efficiency (price equal marginal cost) are achieved in the long run.After long-run adjustments purely competitive markets maximize the combined amounts of consumer surplus and producer surplus.MCQ’s on “The cost of Production”339598082042000The WXY Corporation has fixed costs of $50. Its total variable costs (TVC) vary with output as shown in the following table: Refer to the table. The average total cost of 4 units of output is:$27.50$40.00$52.50$210.00256469187915300Use the following graph to answer the next question: The diagram shows the short-run average total cost curves for five different plant sizes for a firm. The firm experiences economies of scale over the range of plant sizes:1 through 2 only1 through 3 only1 through 53 through 5 only Explicit costs and implicit costs:Are alike in that both represent opportunity costsAre alike in that both reflect an outlay of cashAre alike in that both are deducted from revenue to find accounting profitDiffer in that only explicit costs are deducted from revenue to find economic profit Suppose that a business incurred implicit costs of $300,000 and explicit costs of $1,300,000 over the past year. If the firm earned $1,400,000 in revenue, its:Accounting profits were $400,000 and its economic profits were $100,000Accounting losses were $200,000 and its economic profits were $100,000Accounting profits were $100,000 and its economic profits were zeroAccounting profits were $100,000 and its economic losses were $200,000 Which one of the following short-run cost curves would not be affected by an increase in the wage paid to a firm's labor?Average variable costAverage fixed costAverage total costMarginal CostIf marginal product is positive but falling:marginal cost must also be fallingaverage product must be fallingtotal product is increasing at a decreasing ratetotal product is falling The distinguishing feature of the short run is that:at least one input is fixedOutput is fixedInput prices are variableTechnology is variableThe WXY Corporation has fixed costs of $30. Its total variable costs (TVC) vary with output as shown in the following table: Refer to the table. The marginal cost of the fourth unit of output is: 31817879518400$30$40$50$60 306383493477800Use the following average total cost data to answer the next question. The letters A, B, and C designate three successively larger plant sizes: Refer to the data. In the long run, the firm should use plant size "A" for:All possible levels of output100 to 200 units of output300 to 600 units of output600 or more units of output Suppose a particular firm exhibits constant returns to scale as it increases its output over any reasonable range. If it increases all its inputs by 10%, its:total cost will increase by less than 10%average total cost will increase by 10%output will increase by 10%long run average cost curve will shift to the right by 10% Problems on Pure CompetitionProblem 1:A competitive firm's short-run cost information is shown in this table.OutputFixed CostVariable CostTotal Cost0$9.00$0.00$9.001$9.00$8.00$17.002$9.00$15.00$24.003$9.00$21.00$30.004$9.00$26.00$35.005$9.00$32.00$41.006$9.00$39.00$48.007$9.00$47.00$56.008$9.00$56.00$65.009$9.00$66.00$75.0010$9.00$77.00$86.00Suppose the firm can sell all the output it desires at the market price of $9.10. Compute the firm’s total revenue and its total profit (loss) for the potential output choices shown in the table. What output level maximizes the firm’s profits (or minimizes its losses)?Repeat part a. assuming the price has fallen to $7.10.Answer:The table showing revenue, cost, and profit is completed below.OutputTotal CostTotal RevenueTotal Profit0$9.00$0.00-$9.001$17.00$9.10-$7.902$24.00$18.20-$5.803$30.00$27.30-$2.704$35.00$36.40$1.405$41.00$45.50$4.506$48.00$54.60$6.707$56.00$63.70$7.708$65.00$72.80$7.809$75.00$81.90$6.9010$86.00$91.00$6.00Total revenue is found as price multiply output level. For example, total revenue at an output level of 3 is $9.10 x 3 = $27.30. Total profit is equal to total revenue minus total cost. At 3 units of output, profit = $27.30 – $30.00 = –2.70Total profit is maximized at 8 units of output.The new table is presented below.OutputTotal CostTotal RevenueTotal Profit0$9.00$0.00- $9.001$17.00$7.10- $9.902$24.00$14.20- $9.803$30.00$21.30- $8.704$35.00$28.40- $6.605$41.00$35.50- $5.506$48.00$42.60- $5.407$56.00$49.70- $6.308$65.00$56.80- $8.209$75.00$63.90- $11.1010$86.00$71.00- $15.00The loss is minimized at an output of 6 units.Problem 2:Suppose a competitive firm's cost information is as shown in the table below. Its total fixed cost is $9.00.OutputMarginal costAverage variable costAverage Total Cost0---1$8.00$8.0017.002$7.00$7.50$12.003$6.00$7.00$10.004$5.00$6.50$8.755$6.00$6.40$8.206$7.00$6.50$8.007$8.00$6.71$8.008$9.00$7.00$8.139$10.00$7.33$8.3310$11.00$7.70$8.66Suppose the firm sells its output at a price of $9.10. What is the firm's marginal revenue (MR)? Compare MR to marginal cost (MC) to determine the firm’s profit maximizing (loss-minimizing) output level. Be sure to check whether or not the firm should shut down.What is the firm's per-unit profit (loss) at this output level? What is the firm's total profit (loss) at this output level?Repeat parts a. through d. assuming the price has fallen to $7.10.Repeat again assuming the price has fallen to $6.10Answer:Marginal revenue is equal to price, or $9.10 in this instance.The firm will expand production as long as MR exceeds MC and price exceeds average variable cost. It produces 8 units to maximize profits. Per-unit profit is equal to average revenue, or price, minus average total cost. Per-unit profit = $9.10 – $8.13 = $.97.Total profit is equal to per unit profit ($.97) times the number sold (8). Profit = $7.76.MR = price = $7.10. Comparing to MC, the firm produces 6 units. The firm's per unit loss is $7.10 – $8.00 = –$.90. Since this is negative, check to see if price exceeds average variable cost. At 6 units of output, AVC = $6.50, which is indeed less than price, so the firm should produce 6 rather than shut down. The firm's total loss is $.90 x 6 = $5.40. The firm would lose an amount equal to its fixed cost ($9.00) if it were to shut down.Marginal revenue is $6.10. This is lower than the lowest possible value of average variable cost, so the firm should shut down, losing an amount equal to its fixed cost, or $9.00.Problem 3:A competitive firm's short-run cost information is shown in the table below:OutputMarginal costAverage variable costAverage Total Cost0---1$8.00$8.0017.002$7.00$7.50$12.003$6.00$7.00$10.004$5.00$6.50$8.755$6.00$6.40$8.206$7.00$6.50$8.007$8.00$6.71$8.008$9.00$7.00$8.139$10.00$7.33$8.3310$11.00$7.70$8.66If the market price is $5.25, how much will this firm produce? Enter in the second column of the table below. Repeat for the remaining prices shown in the table.PriceQuantity supplied this firmQuantity supplied 2000 firmsQuantity Demanded this firm$5.2520000$6.2518000$7.2516000$8.2514000$9.2512000$10.2510000Fill in the next column to determine the market supply in this industry, assuming there are 2000 identical firms in the industry.Further suppose that the market demand schedule for this industry is given by the last column in the table.What is the equilibrium quantity in this market?What is the equilibrium price in this market?What are the resulting output, revenue, cost, and profit of the typical firm?Answer:At prices below $6.40, the price is less than minimum average variable cost, so the firm shuts down, producing zero. For other prices, the firm produces at the output corresponding to MR = MC. The table is completed below: PriceQuantity supplied this firmQuantity supplied 2000 firmsQuantity Demanded this firm$5.250020000$6.250018000$7.2561200016000$8.2571400014000$9.2581600012000$10.2591800010000Each value in the third column is 2000 times the value in the second column: total quantity supplied in the market is equal to the number of firms multiplied by the amount produced by the typical firm.Equilibrium quantity is 14,000 units, where market quantity demanded equals quantity supplied.Equilibrium price is $8.25, corresponding to the equilibrium quantity.At a market price of $8.25, the typical firm produces 7 units. Its revenue is $8.25 x 7 = $57.75. Its total cost is $56, equal to its output times its average total cost: $56 = 7 x $8. Its profit is the difference between total revenue and total cost: profit = $57.75 – $56 = $1.75. Alternatively, its profit is equal to output times the difference between price and average total cost: 7 x ($8.25 – $8.00) = $1.75. Question on Elasticity, Consumer & Producer SurplusQuestion 1:Use the following demand schedule to determine total revenue and marginal revenue for each possible level of sales:What can you conclude about the structure of the industry in which this firm is operating? Explain.Graph the demand, total-revenue, and marginal-revenue curves for this firm.Why do the demand and marginal-revenue curves coincide?"Marginal revenue is the change in total revenue associated with additional units of output." Explain verbally and graphically, using the data in the table.Answers:Product PriceQuantity DemandedTotal RevenueMarginal Revenue$2000$2122$2242$2362$2482$25102The industry is purely competitive—this firm is a “price taker.” The firm is so small relative to the size of the market that it can change its level of output without affecting the market priceSee the Graph:The firm’s demand curve is perfectly elastic; MR is constant and equal to P. True. When output (quantity demanded) increases by 1 unit, total revenue increases by $2. This $2 increase is the marginal revenue. Figure: The change in TR is measured by the slope of the TR line, 2 (= $2/1 unit)Question 2:Assume the following cost data are for a purely competitive producer:At a product price of $56, will this firm produce in the short run? Why or why not? If it is preferable to produce, what will be the profit-maximizing or loss-minimizing output? Explain. What economic profit or loss will the firm realize per unit of output?Answer the relevant questions of 4a assuming product price is $41.Answer the relevant questions of 4a assuming product price is $32.In the table below, complete the short-run supply schedule for the firm (columns 1 and 2) and indicate the profit or loss incurred at each output (column 3). Explain: "That segment of a competitive firm's marginal-cost curve which lies above its average-variable-cost curve constitutes the short-run supply curve for the firm." Illustrate graphically.Now assume that there are 1500 identical firms in this competitive industry; that is, there are 1500 firms, each of which has the cost data shown in the table. Calculate the industry supply schedule (column 4).Suppose the market demand data for the product are as follows:What will be the equilibrium price? What will be the equilibrium output for the industry? For each firm? What will profit or loss be per unit? Per firm? Will this industry expand or contract in the long run?Answers:Yes, $56 exceeds AVC (and ATC) at the profit-maximizing output. Using the MR = MC rule it will produce 8 units. Profits per unit = $7.87 (= $56 - $48.13); total profit = $62.96.Yes, $41 exceeds AVC at the loss—minimizing output. Using the MR = MC rule it will produce 6 units. Loss per unit or output is $6.50 (= $41 - $47.50). Total loss = $39 (= 6 ?? $6.50), which is less than its total fixed cost of $60.No, because $32 is always less than AVC. If it did produce according to the MR = MC rule, its output would be 4—found by expanding output until MR no longer exceeds MC. By producing 4 units, it would lose $82 [= 4 ($32 - $52.50)]. By not producing, it would lose only its total fixed cost of $60.Table is given:PriceQuantitysupplied,single firmProfit (+)or loss (l)Quantitysupplied,1500 firms260-600320-600385-557500416-399000467-810500568631200066914413500The firm will not produce if P < AVC. When P > AVC, the firm will produce in the short run at the quantity where P (= MR) is equal to its increasing MC. Therefore, the MC curve above the AVC curve is the firm’s short-run supply curve; it shows the quantity of output the firm will supply at each price level. See Figure 21.6 for a graphical illustration.See above tableEquilibrium price = $46; equilibrium output = 10,500. Each firm will produce 7 units. Loss per unit = $1.14, or $8 per firm. The industry will contract in the long run. ................
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