# ECON 203:Chapter 8 – Perfect Competition

B. marginal cost is below average fixed cost.

C. marginal cost is below average variable cost.

D. average fixed cost is constant.

Explanation:

53. Kate’s 24-Hour Breakfast Diner menu offers one item, a \$5.00 breakfast special.  Kate’s costs for servers, cooks, electricity, food, etc. average out to \$3.95 per meal.  Her costs for rent, insurance cleaning supplies and business license average out to \$1.25 per meal.  Since the market is highly competitive, Kate should

A. raise her prices above the perfectly competitive level set by the market.

B. keep the business open in the short-run, but plan to go out of business in the long-run.

C. keep the business open in the short-run, and plan to expand the business in the long-run.

D. lay-off her staff, break her lease, and close the business down immediately.

Explanation:

Category: Analyze

54. Refer to the table below.  In this instance, confirmation that this firm is operating in a perfectly competitive market can readily be ascertained by the fact that its

A. marginal cost is increasing.

B. total cost is increasing.

C. economic profits are zero.

D. marginal revenue is constant.

Explanation:

55. Refer to the table below.  In this instance, expansion of output

A. causes input prices to rise as demand for inputs increases.

B. leaves input prices constant as demand for inputs increases.

C. causes diseconomies of scale to occur.

D. occurs because of increasing returns to scale.

Explanation:

56. In order to produce 100 oatmeal cookies, GoodieCookieCo incurs an average total cost of \$0.25 per cookie.  The company’s marginal cost is constant at \$0.10 for all oatmeal cookies produced.  The total cost to produce 50 oatmeal cookies is

A. \$25

B. \$20

C. \$50

D. \$60

Explanation:

57. In order to produce 100 pairs of oven gloves, Marcia incurs an average total cost of \$2.50 per pair.  Marcia’s marginal cost is constant at \$10.00 for every pair of oven gloves produced.  The total cost to produce 50 pairs of oven gloves is

A. \$250.00

B. \$500.00

C. \$300.00

D. \$200.00

Explanation:

58. If the average product for six workers is fifteen and the marginal

product of the seventh worker is eighteen, then

A. marginal product is rising.

B. marginal product is falling.

C. average product is rising.

D. average product is falling.

Explanation:

59. In Sam’s greenhouse operation, labor is the only short term variable input.  After completing a cost analysis, if the marginal product of labor is the same for each unit of labor, this will imply that

A. the average product of labor is always equal to the marginal product of labor.

B. the average product of labor is always greater that the marginal product of labor.

C. the average product of labor is always less than the marginal product of labor.

D. as more labor inputs are used, the average product of labor inputs will fall.

Explanation:

Category: Analyze

60. If accounting profits for a firm are 20% of output, and the opportunity cost of financial capital is 8% of output, then what do the firm’s economic profits equal?

A. 6% of output

B. 10% of output

C. 12% of output

D. 8% of output

Explanation:

61. Neil’s Bakery is famous for its giant cinnamon buns.  The bakery has fixed costs of \$100.  Neil must pay each worker a wage of \$10.00 per hour and each works an 8 hour shift.  He earns \$2 for each cinnamon bun that is sold.  The following table shows how many cinnamon buns he can sell, depending on the number of workers he hires.  Refer to the table below.  To maximize his profits in this competitive market, how many workers should he hire?

A. 2 workers

B. 3 workers

C. 4 workers

D. 5 workers

Explanation:

62. In economics, labor demand is synonymous with

A. market demand.

B. average demand.

C. marginal demand.

D. derived demand.

Explanation:

63. Even when competitive firms are unable to calculate marginal revenue product directly, _________________________________________ will push wage rates toward the marginal revenue product of labor.

A. planned future investment in physical capital

B. the pressures of competition in the labor market

C. the marginal workers ongoing skills training

D. wages that exceed workers’ net revenue product

Explanation:

64. In a perfectly competitive market setting, which of the following would be a true statement?

A. Market price automatically sets itself exactly at equilibrium.

B. Market price rarely trends toward the equilibrium value.

C. Wage rates mirror marginal revenue product levels exactly.

D. Wage rates trend toward marginal revenue product levels.

Explanation:

65. When a firm makes plans for investments in physical capital, it compares the _______________ on these investments with ______________________ .

A. projected rates of return; the cost of financial capital to the firm

B. present inputs of physical capital; future hurdle rates

C. present inputs of physical capita; future marginal revenue product

D. projected rates of return; the competitive pressures for labor

Explanation:

66. The table below sets out the amount of capital needed for certain investment projects and the rate of return for each project.  What is this firm’s demand for physical capital if their hurdle rate is 5%?

A. \$11 million

B. \$12 million

C. \$23 million

D. \$33 million

Explanation:

67. The table below sets out the amount of capital needed for certain investment projects and the rate of return for each project.  What is this firm’s demand for physical capital if their hurdle rate is 8%?

A. \$1.5 million

B. \$2 million

C. \$250,000

D. \$500,000

Explanation:

68. When a firm uses retained profits to invest in more energy efficient equipment, an economist would calculate the _________________ of investing in physical capital.

A. typical hurdle rate

B. opportunity cost

C. degree of risk

Explanation:

69. Which of the following can be thought of as an adjustment for the risks involved with respect to the cost of a firm acquiring financial capital?

A. higher retained earnings from past profits

B. cost of financial capital paid by a firm

C. imposition of hurdle rates of interest

D. tax credits for physical capital investments

Explanation:

70. If a firm is producing so that the point chosen along the production possibility frontier is socially preferred, then that firm is said to have reached its

A. allocative efficiency

B. productive efficiency

C. utility-maximizing efficiency

D. minimum price efficiency

Explanation:

Essay Questions

1. Briefly explain what a market will show if perfectly competitive firms produce at the minimum of the long-run average cost curve and explain why this happens.  Briefly explain what the market will illustrate when perfectly competitive firms produce at the quantity where P = MC and explain why this happens.

Reference:

Explanation: When perfectly competitive firms produce at the minimum of the long-run average cost curve, the market will show productive efficiency, since all the firm’s are producing at the lowest possible average cost.

When perfectly competitive firms produce at the quantity where P = MC, the market will illustrate allocative efficiency, since each good is being produced up to the quantity where the amount that the good benefits society, which is measured by the price people are willing to pay, is equal to the cost to society, which is measured by the marginal cost of production.

2. Briefly explain the nature of a perfectly competitive firm.  Briefly discuss the effects of new entrants into a perfectly competitive market on existing firms that have profits in the short run.

Reference:

Explanation: A perfectly competitive firm is a price taker, which means that it must accept the prices at which its sell goods and the prices at which it purchases inputs as determined in the market.  Firms in a highly competitive market may earn profits in the short run,  but the entry of new firms or the expansion of existing firms means that such profits will not persist in the long run.

3. Briefly describe what the effect of producing a greater quantity of products will be in relation to a perfectly competitive firm.

Reference:

Explanation: As a perfectly competitive firm produces a greater quantity of output, its total revenue steadily increases at a constant rate determined by the given market price.

4. Briefly contrast when losses will be the smallest for a perfectly competitive firm based on total revenues with when losses for such a firm will be smallest based on marginal revenue.

Reference:

Explanation: Losses will be smallest for a completely competitive firm at the quantity of output where total revenues exceed total costs by the greatest amount, or where total revenues fall short of total costs by the smallest amount.  Alternatively, losses will be the smallest where marginal revenue, which is price for a perfectly competitive firm, is equal to marginal cost.

5. Briefly explain the relationship between market price and a firm’s profitability in perfectly competitive market.

Reference:

Explanation: If the market price faced by a perfectly competitive firm is above average cost at the profit-maximizing quantity of output, then the firm is making profits.  If the market price is below average cost at the profit-maximizing quantity of output, then the firm is making losses.  If the market price is at average cost, at the profit-maximizing level of output, then the firm is making zero profits.

6. Briefly explain how the zero profit point and the shutdown point for a firm operating in a perfectly competitive market are each determined.

Reference:

Explanation: For a firm operating in a perfectly competitive market, the point where the marginal cost curve crosses the average cost curve, at the minimum of the average cost curve, is called the zero profit point.  The point where that firm’s marginal cost curve crosses the average variable cost curve is called the shutdown point.

7. Briefly discuss physical capital investment and long-run average cost in relation to a perfectly competitive market.

Reference:

Explanation: In a perfectly competitive market, firms seek out the combination of variable inputs like labor and fixed inputs like physical capital investment inputs that will allow them to produce at the minimum of the long-run average cost curve.  If a firm does not produce at the lowest possible average cost, then firms with a lower cost of production will be able to sell at a lower price. Thus, the pressure of competition between firms will shape both the specific kinds of machinery and equipment and the overall quantity of investment in physical capital.

8. Briefly contrast how firms in a perfectly competitive market will respond to long-run profits and losses.  Include an explanation of each response affects the price level.

Reference:

Explanation: In the long run, firms will respond to profits through a process of entry, where existing firms expand output and new firms enter the market.  Conversely, firms will react to losses in the long run through a process of exit, in which existing firms reduce output or cease production altogether.  Through the process of entry in response to profits and exit in response to losses, the price level in a perfectly competitive market will move toward the zero-profit point where the marginal cost curve crosses the average cost curve, at the minimum of the average cost curve.

9. Briefly explain what is meant by: 1) account profit; 2) economic profit; and 3) zero economic profit.

Reference:

Explanation: Accounting profit is measured by taking total revenues and subtracting expenditures.  Economic profit is measured after taking total revenue, subtracting all expenditures, and also subtracting the opportunity cost of financial capital.  Thus, zero economic profit actually means a normal accounting rate of profit.