·FIRM BEHAVIOR AND THE ORGANIZATION OF INDUSTRY
• Because a competitive firm is a price taker, its revenue is proportional to the amount of output it produces. The price of the good equals both the firm’s average revenue and its marginal revenue.
• To maximize profit, a firm chooses a quantity of output such that marginal revenue equals mar- ginal cost. Because marginal revenue for a com- petitive firm equals the market price, the firm chooses quantity so that price equals marginal cost. Thus, the firm’s marginal-cost curve is its supply curve.
• In the short run when a firm cannot recover its fixed costs, the firm will choose to shut down temporarily if the price of the good is less than average variable cost. In the long run when the firm can recover both fixed and variable costs, it
KEY CONCI.PJ:S. competitive market, p. 280 average revenue, p. 281
1. What is meant by a competitive firm? 2. Explain the difference between a firm’s revenue
and its profit. Which do firms maximize? 3. Draw the cost curves for a typical firm. For a
given price, explain how the firm chooses the level of output that maximizes profit. At that level of output, show on your graph the firm’s total revenue and total costs.
4. Under what conditions will a firm shut down temporarily? Explain.
1. Many small boats are made of fiberglass, which is derived from crude oil. Suppose that the price of oil rises. a. Using diagrams, show what happens to the
cost curves of an individual boat-making firm and to the market supply curve.
b. What happens to the profits of boat makers in the short run? What happens to the number of boat makers in the long run?
2. You go out to the best restaurant in town and order a lobster dinner for $40. After eating half
will choose to exit if the price is less than average total cost.
• In a market with free entry and exit, profits are driven to zero in the long run. In this long-run equilibrium, all firms produce at the efficient scale, price equals the minimum of average total cost, and the number of firms adjusts to satisfy the quantity demanded at this price.
• Changes in demand have different effects over different time horizons. In the short run, an increase in demand raises prices and leads to profits, and a decrease in demand lowers prices and leads to losses. But if firms can freely enter and exit the market, then in the long run, the number of firms adjusts to drive the market back to the zero-profit equilibrium.
marginalrevenue,p.282 sunk cost, p. 286
5. Under what conditions will a firm exit a ” market? Explain. ( 6:\Does a firm’s price equal marginal cost in the ~–thort run, in the long run, or both? Explain. V Does a firm’s price equal the minimum of
average total cost in the short run, in the long run, or both? Explain.
8. Are market supply curves typically more elastic in the short run or in the long run? Explain.
of the lobster, you realize that you are quite full. . Your date wants you to finish your dinner because . you can’t take it home and because “you’ve already paid for it.” What should you do? Relate your answer to the material in this chapter.
3. Bob’s lawn-mowing service is a profit-maximizing, competitive firm. Bob mows lawns for $27 each. His total cost each day is $280, of which $30 is a fixed cost. He mows 10 lawns a day. What can you say about Bob’s short-run decision regarding shutdown and his long-run decision regarding exit?
total cost and total revenue given in following table:
012 3 4 56 7
Total cost Total revenue
$8 9 10 $0 8 16
11 13 19 27 37 . ‘ ‘ 24 32 40 48 .Sf> ·
a. Calculate profit for each quantity. How much should the firm produce to maximize profit?
b. Calculate marginal revenue and marginal cost for each quantity. Graph them. (Hint: Put the points between whole numbers. For example, the marginal cost between 2 and 3 should be graphed at 2~.) At what quantity do these curves cross? How does this relate to your answer to part (a)?
c. Can you tell whether this firm is in a competitive industry? If so, can you tell whether the industry is in a long-run equilibrium?
5. Ball Bearings, Inc. faces costs of production as follows:
Total Total Fixed Variable
Quantity Costs Costs
0 $100 $ 0 1 100 50 2 100 70 3 100 90 4 100 140 5 100 200 6 100 360
a. Calculate the company’s average fixed costs, average variable costs, average total costs, an~ marginal costs at each level of production.
b. The price of a case of ball bearings is $50. Seeing that she can’t make a profit, the Chief Executive Officer (CEO) decides to shut down operations. What are the firm’s profits/ losses? Was this a wise decision? Explain.
c. Vaguely remembering his introductory economics coutse, the Chief Financial Officer tells·the CEO it is better to produce 1 case of ball bearings, because marginal revenue equals marginal cost at that quantity. What are the firm’s profits/losses at that level of production? Was this the best decision? Explain.
6. Suppose the book-printing industry is competitive and begins in a long-run equilibrium. a. Draw a diagram describing the typical firm
in the industry. b. Hi-Tech Printing Company invents a new
process that sharply reduces the cost of
CHAPTER 14 FIRMS IN COMPETITIVE MARKETS
printing books. What happens to Hi-Tech’s profits and the price of books in the short run when Hi-Tech’s patent prevents other firms from using the new technology?
c. What happens in the long run when the pat~nt expires and other firms are free to use the technology?
7. A firm in a competitive market receives $500 in total revenue and has marginal revenue of $10. What is the average revenue, and how many units were sold? .
8. A profit-maximizing firm in a competitive market is currently producing 100 units of output. It has average revenue of $10, average total cost of $8, and fixed costs of $200. a. What is its profit? b. What is its marginal cost? c. What is its average variable cost? d. Is the efficient scale of the firm more than,
~ less than, or exactly 100 units?
The market for fertilizer is perfectly competitive. Firms in the market are producing output, but are currently making economic losses. a. How does the price of fertilizer compare to
the· average total cost, the average variable cost, and the marginal cost of producing fertilizer?
b. Draw two graphs, side by side, illustrating the present situation for the typical firm and in the market. ‘
c. Assuming there is no change in either demand or the firms’ cost curves, explain what will happen in the long run to the price of fertilizer, marginal cost, average total cost, the quantity supplied by each firm, and the total quantity supplied to the market.
10. The market for apple pies in the city of Ectenia is competitive and has the following demand schedule:
Price Quantity Demanded
$ 1 1.200 pies 2 1,100 3 1,000 4 %0 5 800 6 700 7 600 8 500 9 400
10. . 300
11 200 12 100 13 0 .