Microeconomics Chapter 12 Test Answers

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Firms are said to be in perfect competition when the following conditions occur: many firms produce identical products; (2) many buyers are available to buy the product, and many sellers are available to sell the product; (3) sellers and buyers have all relevant information to make rational decisions about the product being bought and sold; and (4) firms can enter and leave the market without any restrictions—in other words, there is free entry and exit into and out of the market.

A perfectly competitive firm is known as a price taker because the pressure of competing firms forces them to accept the prevailing equilibrium price in the market. If a firm in a perfectly competitive market raises the price of its product by so much as a penny, it will lose all of its sales to competitors.

When a wheat grower, as discussed in the Bring it Home feature, wants to know what the going price of wheat is, he or she has to go to the computer or listen to the radio to check. The market price is determined solely by supply and demand in the entire market and not the individual farmer. Also, a perfectly competitive firm must be a very small player in the overall market, so that it can increase or decrease output without noticeably affecting the overall quantity supplied and price in the market.

A perfectly competitive market is a hypothetical extreme; however, producers in a number of industries do face many competitor firms selling highly similar goods, in which case they must often act as price takers. Agricultural markets are often used as an example. The same crops grown by different farmers are largely interchangeable. According to the United States Department of Agriculture’s monthly reports, in 2015, U.S. corn farmers received an average price of $6.00 per bushel and wheat farmers received an average price of $6.00 per bushel.

A corn farmer who attempted to sell at $7.00 per bushel, or a wheat grower who attempted to sell for $8.00 per bushel, would not have found any buyers. A perfectly competitive firm will not sell below the equilibrium price either. Why should they when they can sell all they want at the higher price? Other examples of agricultural markets that operate in close to perfectly competitive markets are small roadside produce markets and small organic farmers.

Terms and Answers to Learn

What conditions make a market perfectly​ competitive?
A market is perfectly competitive if:

1. Many buyers and sellers. Each individual buyer and seller is small relative to the entire​ market, and, as a​ result, cannot affect the market price.

2. All firms sell identical products. There can be no verifiable difference between the goods and services sold under perfect competition.

3. There are no barriers to entry into the market.

How should firms in perfectly competitive markets decide how much to​ produce?
Perfectly competitive firms should produce the quantity where

Perfectly competitive firms cannot control price and are consequently price takers. Economists assume that the objective of such firms is to maximize profit​ (total revenue minus total​ cost).

​Therefore, to maximize​ profit, a firm should produce the quantity of output where the difference between total revenue and total cost is as large as possible.

Total revenue equals:

Price multiplied by Quantity


Average revenue equals:

Total revenue divided by the Quantity


Marginal revenue is:

the change in total revenue from selling one more unit of a​ product

MR= change in TR/change in Q

Which of the following is an expression of profit for a perfectly competitive​ firm?

Profit for a perfectly competitive firm can be expressed as:

Profit= (P-ATC)xQ
This is because…Profit= TR-TC
Profit= (PxQ)-TC
divide all by Q
—> Profit/Q=(PQ)/Q-TC/Q
This turns into Profit/Q=P-ATC, because ATC=average total cost=TC/Q.
sooo, if you multiply it all by Q,
Profit= (P-ATC)xQ

The figure to the right represents the cost structure for a perfectly competitive firm with its average total cost​ (ATC) curve, average variable​ (AVC) curve, and marginal cost​ (MC) curve. Fixed costs are​ $50.00.

Suppose the market price is ​$24.00 per unit.
Characterize the​ firm’s profit.

If the firm produces​ output, then it will:

experience losses
Production decision in the short​ run: If the firm​ produces, then it will produce an output level where price equals marginal cost.
If price is greater than average total​ cost, then the firm will make a profit.
If price is equal to average total​ cost, then the firm will break even.
If price is less than average total​ cost, then the firm will experience losses.
If price is greater than average total​ cost, then the firm will make a profit.
If price is equal to average total​ cost, then the firm will break even.
If price is less than average total​ cost, then the firm will experience losses.

​Shut-down point in the short​ run: In the short​ run, if price is greater than average variable cost​, then the firm should:

​However, if price is less than average variable cost​:

continue to produce​ (because the firm would lose an amount less than fixed costs by shutting​ down).

the firm should stop production by shutting down.

​Break-even point:
A firm is breaking even when its total cost equals its total revenue.
Economic​ profit:
A​ firm’s revenues minus all its​ costs, implicit and explicit.
Since accounting profit generally only includes explicit​ costs:

breaking even corresponds to positive accounting profit.

When breaking​ even, the wheat farmer should continue to produce in the long run because this is as high a return as she could earn elsewhere.
Because economic profit takes into account all of the wheat​ farmer’s costs, she should continue to produce because she can cover all her implicit opportunity costs.

Entry and exit​ decisions in the long​ run:

If P​ > ATC​, then new firms will enter the market. If new firms​ enter, then the market supply curve will shift to the right(increase) and decrease the market price.

If P​ < ATC, then existing firms will exit. If existing firms​ exit, then the market supply curve will shift to the​ left(decrease), and increase the market price.

What determines entry and exit of firms in a perfectly competitive industry in the long​ run?
In a perfectly competitive industry in the long​ run,

new firms will enter if existing firms are making a profit and existing firms will exit if they are experiencing losses.

Entry and exit​ decisions: Profits and losses provide signals to firms that lead to entry and exit in the long run.
For​ example, unless a firm can cover all its​ costs, it will shut down and exit the industry.
More​ precisely, new firms will enter if existing firms are making a profit and existing firms will exit if they are experiencing losses.

​Long-run competitive​ equilibrium:

The situation in which the entry and exit of firms has resulted in the typical firm breaking even.

The​ long-run equilibrium market price is at a level equal to the minimum point on the typical​ firm’s average total cost curve.

Profits and​ losses:
If P​ > ATC, then a firm will make a profit.
If P​ = ATC, then a firm will break even.
If P​ < ATC, then a firm will experience losses.
When firms are making a profit, in the long run:
firms will enter the market until the marginal firm is earning zero economic profit
Wheat farming:
Retail bookselling:
Manufacturing cell phones:
Bridge building:

Perfectly competitive, many firms, identical product, high ease of entry

not p.c, many firms, differentiated product, high e.o.e

not p.c., few firms, differentiated, low e.o.e.

not p.c., few firms, differentiated, low e.o.e

P x Q
A firm makes a profit if:
A firm experiences a loss if:

Profit equals revenue minus total cost ​(TC​), where revenue equals price multiplied by​ quantity:

Stated​ differently, this is equal to the profit margin​ (the difference in price and average total​ cost) multiplied by​ quantity:

The firm will break​ even, earning neither positive economic profits nor incurring​ losses, if:

Profit= (PxQ)-TC
Profit= (P-ATC)xQprice equals the average total cost of production.
The shutdown point is:
the minimum point on a​ firm’s average variable cost​ curve; if the price falls below this​ point, the firm shuts down production in the short run.
This is because if price is less than the average variable cost of​ production, then the firm is not receiving enough revenue from producing to cover its variable​ costs, with no money left over to pay for any of its fixed costs. If the firm shuts​ down, then its loss equals the fixed cost of production.
In perfectly competitive​ markets, prices are determined by
the interaction of market demand and market supply
In perfect​ competition, long-run equilibrium occurs when the economic profit is
What is a price​ taker?
A price taker is:
a firm that is unable to affect the market price.
When are firms likely to be price​ takers?
A firm is likely to be a price taker when:
it represents a small fraction of the total market
Why do single firms in perfectly competitive markets face horizontal demand​ curves?
With many firms selling an identical​ product, single firms have no effect on market price.


Microeconomics – Chapter 12: Firms in Perfectly Competitive Markets Video

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