CHAPTER 9
PERFECT COMPETITION
EVEN NUMBER ANSWERS, SOLUTIONS, AND EXERCISES
ANSWERS TO ONLINE REVIEW QUESTIONS
2. Many markets are reasonably close to perfect competition, and by using the model of
perfect competition, we can make valuable predictions about those markets. Perfect
competition approximates and gives accurate enough predictions in a variety of markets.
4. The demand curve facing a perfectly competitive firm is infinitely elastic since a
perfectly competitive firm is a price taker. If such a firm increases its price above the
going market price, it would lose all of its customers; it will not lower its price below the
market price because it does not have to (it can sell all the output it wants without
lowering its price).
6. Comparing price and ATC tells us the firm’s profit per unit, which can then be multiplied
by the number of units to obtain total profit. But the firm’s goal is to maximize total
profit, not profit per unit. Looking at price and ATC doesn’t tell us what level of output
maximizes total profit. For this, we need to look at price and marginal cost.
8. a. Uncertain. When price exceeds minimum AVC, the firm will not shut down, but its
profit could be positive (if P > ATC > AVC) or negative (if AVC < P < ATC).
b. False. A competitive firm’s supply curve coincides with the marginal cost curve for
all prices above the minimum point on the AVC curve. For all prices below the
minimum point on the AVC curve, the supply curve is vertical at zero units of output.
10. False. Output increases in the long run as more firms enter the market. If the firms are
entering a constant cost industry or a decreasing cost industry, the price will not increase.
PROBLEM SET
2.
Q
0
1
TVC
$0
MC
MR
6
5
6
5
2
3
4
5
6
28
6
12
5
–7
6
17
10
–7
6
21
15
–6
6
24
20
–4
6
28
25
–3
6
34
30
–4
5
22
6
Economic
Profit
–$6
5
18
4
TR
$0
5
15
3
TC
$6
5
11
4
TFC
$6
5
a. Using the MR and MC approach, we know that, when marginal cost is increasing, the firm
should increase output if MR>MC for that additional output, and not increase output if
MR<MC. We see that marginal cost begins to increase with the production of the 5th unit.
For the 5th unit MR>MC, so the firm should produce it. For the 6th unit, however, MR<MC,
so the firm should not produce it. We see that the profit maximizing output level is Q* = 5.
b.
Since the firm’s TC always exceeds its TR, its goal becomes to minimize its economic
loss. This occurs at Q* = 5, where economic profit = –$3
4. a. The market equilibrium price—where quantity supplied equals quantity demanded—is
$2.00 per pound. Thus, each individual firm will face a price of $2.00, which is also its
marginal revenue. From the total cost column, we can calculate that marginal cost is $1.00 per
pound for increases from 60,000 to 61,000, and from 61,000 to 62,000. When output increases
from 62,000 to 63,000, however, MC = $3.00. Since MR > MC for increases in output up to
62,000, but MR < MC beyond 62,000, the typical firm should produce a profit-maximizing
output of 62,000 pounds.
b. At 62,000 pounds, ATC = TC/Q = $112,000/62,000 = $1.81. Since P > ATC, the firm is
earning a profit. Profit will attract entry, so this market is not in long-run equilibrium.
c. The profit that the firm is earning will attract entry, so that the number of firms in the
market will increase.
6.
Yes. In the short run, a higher price induces existing firms to produce more output, while in
the long run, a higher price also induces entry. For any given price increase, the quantity supplied
will be higher with entry than with no entry. Consequently, the supply curve is flatter in the long
run than in the short run.
8.
a.
Output
Price
Total
Revenue
0
$50
$0
Marginal
Revenue
Total Cost
$5
$50
$35
$50
$40
$10
$50
2
$50
$15
$100
$55
$45
$50
3
$50
$35
$150
$90
$60
$50
4
$50
Profit
-$5
$50
1
Marginal
Cost
$55
$200
$145
$55
$65
This firm’s short-run profit-maximizing quantity of output is 3 (found by expanding output as long
as marginal revenue exceeds marginal cost). This firm will earn a profit of $60.
b.
Output
Price
Total
Revenue
0
$50
$0
Marginal
Revenue
Total Cost
$10
$50
1
$50
$50
$50
-$10
$45
$100
$5
$15
$60
$50
Profit
$35
$50
2
Marginal
Cost
$40
$35
3
$50
$150
$95
$50
4
$50
$200
$55
$55
$150
$50
$50
$65
The firm’s profit-maximizing quantity of output remains at 3 units, but its profit falls to $55.
c.
Output
Price
Total
Revenue
0
$50
$0
Marginal
Revenue
Total Cost
$5
$50
1
$50
$50
$50
$50
$95
$150
$50
$5
$55
$150
$50
4
-$10
$35
$50
3
-$5
$60
$100
$200
$0
$75
$225
$50
Profit
$55
$50
2
Marginal
Cost
-$25
$85
The firm’s profit-maximizing quantity of output falls to 2 units, and its profit falls to $5.
10.
Suppose the perfectly competitive market and representative firm are initially in
equilibrium at point A. In the left-hand panel, market output is Q1 and price is P1. The
right-hand panel shows that the typical firm facing price P1 produces q1 units of output
(at the minimum point of its long-run average total cost curve, LRATC1).
Now suppose that market demand decreases from D1 to D2. Firms that are already
in the market react by cutting back production. As they do so, the market price will fall
to PSR at the intersection of market supply curve S1 and new market demand curve D2. At
this low price, however, each of those firms will be suffering a loss. Some of them will
leave the industry. As they do so, the market supply curve will shift inward.
Because this is an increasing cost industry, the reduction in market output will cause
each firm's LRATC curve to shift downward. The shifts will continue until each firm is just
breaking evenat point C. In the new long-run equilibrium (point C), both the market
price and quantity are lower than before the reduction in market demand (old long-run
equilibrium at point A); the output of the typical firm is unchanged at q1.
The upward-sloping, long-run market supply curve, SLR, is found by connecting points
A and C, both of which are points of long-run equilibrium.
12. a)In the short run, demand for solar panels increases from D1 to D2. Keeping the supply curve
constant, this brings us to the short-run equilibrium point B at which PSR>P1. In the long
run two things happen. First, firms start entering the market because they can sell at a high
price (PSR), which shifts the supply curve to the right. Second, technological improvements
shift the LRATC curve downward from LRATC1 to LRATC2 for each individual firm.
Hence, given the price and any number of firms in the market, output will be higher because
technological improvements allow each firm to produce at a lower cost. This also shifts the
supply curve to the right. Finally, we end up at a long-run equilibrium point C.
Market
Price per
Peak Watt
S1
S2
B
PSR
P1
A
C
P2
D2
D1
Q1
Q2
Quantity of
Solar Panels
b) In the new, final long-run equilibrium (point C), the price of solar panels is lower than it
was initially (at point A).
Firm
Price per
Peak Watt
LRATC1
LRATC2
d1 = MR1
P1
d2 = MR2
P2
Q1
Quantity of
Solar Panels
14.a. In the left-hand panel, imposition of the excise tax will shift the short-run supply curve
vertically by the amount of the tax – from S1 to S2. In the short run, the demand curve will not
change, so the new equilibrium is found at point B where supply curve S2 crosses unchanged
demand curve D1. Each firm in the industry will find that its average total cost has increased by the
amount of the tax.
b. In the long run, the typical firm’s LRATC curve (right-hand panel) will shift upward by the
amount of the tax – from LRATC1 to LRATC2. You can see that the short-run demand
curve (dotted) corresponding to new short-run market price P2 – lies below LRATC2 at each
possible output level. Consequently, each firm in this market will suffer a loss, and some of
them will leave the industry.
As firms do leave the industry, the market supply curve will shift farther to the left – to S3.
However, because it is a constant-cost industry, this exit will not affect firms’ LRATC
curves. Exit will continue until the market price reaches P3. At that price, each of the
remaining firms will just break even – with zero economic profit. In other words, the
market is back in long-run equilibrium at point C.
c. Notice that the excise tax, the vertical shift of the LRATC curve, and the change in the
market price are all the same. The fact that the market price has risen by the full amount of
the tax tell us that all of the tax is paid by buyers.