Chapter 9 Perfect Competition

CHAPTER 9 - PERFECT COMPETITION

ANSWERS TO EVEN-NUMBERED PROBLEMS

2.
Economic
Q TVC MC MR TFC TC TR Profit
0 $0 $6 $6 $0 $6

6 5
1 6 6 12 5 7

5 5
2 11 6 17 10 7

4 5
3 15 6 21 15 6

3 5
4 18 6 24 20 4

4 5
5 22 6 28 25 3

6 5
6 28 6 34 30 4

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 firms 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 pricewhere quantity supplied equals quantity demandedis $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.
 Chapter 9 Perfect Competition

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 Marginal Total Cost Marginal Profit
Revenue Revenue Cost
0 $50 $0 $5 -$5
$50 $35
1 $50 $50 $40 $10
$50 $15
2 $50 $100 $55 $45
$50 $35
3 $50 $150 $90 $60
$50 $55
4 $50 $200 $145 $55
$65
This firms 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 Marginal Total Cost Marginal Profit
Revenue Revenue Cost
0 $50 $0 $10 -$10
$50 $35
1 $50 $50 $45 $5
$50 $15
2 $50 $100 $60 $40
$50 $35
3 $50 $150 $95 $55
$50 $55
4 $50 $200 $150 $50
$50 $65

The firms profit-maximizing quantity of output remains at 3 units, but its profit falls to $55.
c.
Output Price Total Marginal Total Cost Marginal Profit
Revenue Revenue Cost
0 $50 $0 $5 -$5
$50 $55
1 $50 $50 $60 -$10
$50 $35
2 $50 $100 $95 $5
$50 $55
3 $50 $150 $150 $0
 Chapter 9 Perfect Competition

$50 $75
4 $50 $200 $225 -$25
$50 $85

The firms profit-maximizing quantity of output falls to 2 units, and its profit falls to $5.

10.

Market Firm
Price Dollars
per Unit
S2 LRATC1
S1
SLR A LRATC2
P1 P1 d1 = MR1
A
P2 P2 d2 = MR2
C C
B D1
PSR

D2

Q2 Q1 Output per q1 Output per

Period Period

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 D 1 to D2. Firms that are already in the
market react by cutting back production. As they do so, the market price will fall to P SR 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 evenat 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.
 Chapter 9 Perfect Competition

12.

MORE CHALLENGING QUESTIONS

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 S 2 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.

Price Price per

Market Firm
per Unit S3 Unit LRATC2
S2
P3 C P3 C
B S1
P2 P2 LRATC1
A P1 d1 = MR1
P1 A

D1

Q3 Q2 Q1 Output per q1 Output per

Period Period
 Chapter 9 Perfect Competition

b. In the long run, the typical firms LRATC curve (right-hand panel) will shift upward by the
amount of the tax from LRATC 1 to LRATC2. You can see that the short-run demand curve
(dotted) corresponding to new short-run market price P 2 lies below LRATC 2 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 S 3.
However, because it is a constant-cost industry, this exit will not affect firms LRATC curves.
Exit will continue until the market price reaches P 3. 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.