Perfect Competition Free Response Questions
1. Alan’s Apple Farm is a perfectly competitive apple grower, and the business is
currently in long-run equilibrium.
a. Draw side by side graphs that represent the market for apples and Alan’s
Apple Farm. Be sure to indicate the market quantity and the quantity produced
by the firm.
b. All apple farms use pesticides, and they pay the pesticide sprayer a lump-sum
payment once a year. The sprayer has decreased the price of his services from
$1500 to $1000 a year. Illustrate the effect of this decreased cost on the firm,
and be sure to illustrate and explain what happens to:
i. The quantity produced by the firm
ii. The price of apples in the market
iii. The profit situation for the firm
c. Describe how the situation in part b adjusts in the long run. Illustrate and
explain how the following changes in the long run:
i. Price of apples in the market
ii. Quantity of apples produced by the market
iii. Quantity of apples produced by the firm
iv. The profit situation for the firm
2. Sam’s Sunflowers is a perfectly competitive sunflower farm, and the business is
currently incurring a loss.
a. Draw side by side graphs that represent the market for sunflowers and the
individual firm. Be sure to indicate the market quantity and the quantity
produced by the firm.
b. Is this firm currently operating in the short run or long run? Explain.
c. Describe how this situation adjusts in the long run. Illustrate and explain how
the following changes:
i. Price of sunflowers in the market
ii. Quantity of sunflowers produced by the market
iii. Quantity of sunflowers produced by the firm
iv. The profit situation for the firm
Answer Key
1.
a.
(note: pay attention to labels – I will be looking for ALL of these!)
b.
i. Quantity produced by firm stays the same – price (MR) did not change, and
they will profit maximize at MC = MR
ii. Price of apples does not change – market for apples not affected by fixed cost
(therefore, ATC) decreasing for the firms, and firms cannot affect market price
(price-takers)
iii. Firm is now profiting (see orange shaded in rectangle). Pesticides are a
fixed cost (yearly payment) and a decrease in fixed cost causes a decrease in
average total cost.
c.
i.
Market price of apples decreases because of an increase in market supply of
apples – firms have entered the market in search of profits.
ii. Market quantity of apples produced has increased because of the increase in
market supply
iii. Firm produces fewer apples (QF1) because they will profit maximize where MC =
the new MR (MR1)
iv. Firm now breaks even in the long run.
2.
a.
b. Firm is currently operating in the short run – they are incurring a loss (illustrated in
the rectangle shaded above)
c.
i.
Because firms are losing money, firms will exit the market (market supply
decreases), which increases the price of sunflowers to PM1.
ii. Market quantity of sunflowers will decrease to QM1 because of the decrease in
market supply
iii. Firm produces more sunflowers than before (QF1) because of the new increased
price (MR1) and they will maximize profits where this new MR = MC.
iv. The firm now breaks even in the long run.