Problem Set 8
Perfect competition
1) What is the main difference between accounting profits and economic profits?
a) Accounting profits take into account sunk costs whereas economic profits do not.
b) Accounting profits are not as rigorously calculated as economic profits.
c) Accounting profits take into account only explicit costs were economic profits consider both explicit and implicit costs.
d) Accounting profits and economic profits are basically the same.
e) Accounting profits use a different method to calculate total revenue than is used in calculating economic profits.
2) Which of the following is not true when a firm is maximizing profits?
a) The firm's supply curve is equal to the market's demand curve.
b) The difference between total revenue and total cost is as large as possible.
c) Marginal revenue is equal to marginal cost.
d) The marginal cost curve intersects the firm's demand curve at the optimal output level.
e) Total revenue is greater than or equal to total variable cost.
3) Which of the following choices lists attributes of an industry or market that are not likely to be perfectly competitive?
a) The production process in the industry has decreasing average total costs.
b) The products produced by each firm are treated as perfect substitutes by consumers.
c) It is easy for firms to enter and exit the industry.
d) The demand curve that each firm faces is perfectly elastic.
e) Firms earn zero economic profits.
4) For each firm in a competitive industry the long run average total costs are given by, LRATC = q2 - 10q + 100. It can be shown (by taking the derivative of total costs) that all firms have a marginal cost curve given by, MC = 3q2 - 20q + 100. [Note: We will always provide as needed or else sufficient information to find MC: you do not need to know calculus to do this problem or any other problem in Econ 101.] Assume that the market demand is given by QD = -2P + 1,000.
Hint: thinking about the implied graph(s) before starting any calculations may most easily solve this question.
a) What level of output will each firm choose?
b) What will the market price be?
c) What is market demand?
d) How many firms will there be in the industry?
e) What are the firms' economic profits in the long run?
5) Suppose for the industry described in question 4 there is an increase in the market demand for the good. Let the new demand curve be given by
QD = -2P + 1,196.
a) Describe verbally what will occur in the short run. It is a good idea to draw a graph. What will happen once new firms are able to enter the market?
b) In the short run, each firm's supply curve will be their marginal cost curve. After a few creative calculations it turns out that each firm will produce 6 units of output in the short run. Calculate one firm's short run profits.
c) Once new firms are able to enter, approximately how many new firms will there be? Hint: the total production in the market divided by the production of the representative firm will not be a whole number.