Costs of Production and Perfect Competition

Unit 3: Costs of Production and Perfect Com etition CalCulate MP PIot TP and MP on Gralh Number of Total Marginal Workers Product Product 0 0 1 5 !:" u 1 2 15 '1 19 3 - 20 6 . . -d. 5 20 18. 20 15 \ 4 D Output 10 0 J 5 0 1 2 3 4 5 6 Workers Identify the three stages of returns: increasing, decreasing, and negative marginal returns Short Run Cost Curves (at least one fixed resource) Draw and Label ATC, AVC, and MC Costs Costs (I-ions appear at the back ofthe book.• '!ffeck y0 ur Understanding 1. Draw as.b-orr-run dia gram showing a LI-shaped average total cost cur';?e, a LI-shaped average variable cost curve, and a "swoos�;, -shaped marginal cost curve. On it, indicate the range of prices for which the following actions are optimal. a. The 5rm shuts down immediately. b. The firm opera tes in the short run despite sustaining a loss. c. The firm operates while making a profit. 2. The state ofMaine has a very active lobster industry, which_ harvests lobsters during the summer months. During the rest of the year, lobsters can be obtained by restaurants from producers in other parts of the world, but at a m.uch. higher price. Maine is also full of"lobster shacks/' roadside restaurants serving lobster c4sh�s that are open only during the summer. Supposing that the market demand for lobster dishes remains the same throughout the year, explain why it is optimal for lobster shacks to operate only during the summer. Tackle u1e Test: Multiple-Choice Questions For que stio,ns 1-3, refer to the graph provided. Market Price = $20 Price, cost of bushel $20 I-----...Js.--------,,,t:--- 15 14 0 10 20 30 40 50 60 70 Quantity of tomatoes (bushels) 1. The firm's total revenue is equal to a. $14. b. $20. c. $560. d. $750. �1,000. 3. The firm is earning a a. profit equal to $5. �ofit equal to $250. c. loss equal to $15. d. loss equal to $750. e. loss equal to $250. 4. A firm should continue to produce in the short run as long as price is at least equal to a. MR b. MC. c. minimum. ATC. �nimumAVC. e. AFC. S. At prices that motivate the firm to produce at all1 the short-run supply curve for a perfect competitor corresponds to which curve? a. the ATC curve b. the AVC curve �eMCcurve d. the AFC curve e. the MR curve 2. The firm's total cosc is equal to a. $14. b. $15. c. $560. �750. e. $1,000. Graphing Perfect Competition Tackle the Test: Free-Response Questions Draw a correctly labeled graph showing a perfectly competitive firm producing and incurring a loss in the short run. 2. Refer to the graph provided. Answer (1 o points) Price, cost of bushel Market Price = $20 Price, cost of unit ATC AVC 0 a· 4 6 Quantity 1 point: Demand curve is horizontal and labeled with some combination of "P," "MR," or "D." 1 point: MC is labeled and slopes upward In the shape of a swoosh. 1 point: Profit-maximizing quantity is labeled (for example, as "Q"") on the horizontal axis where MC= MR. 10 12 14 a. Assuming it is appropriate for the firm to produce in the short run, what is the firm's profit-maximizing level of output? � /I� C b. Calculate the firm's total revenue. � / c. Calculate the firm's total cost. tf , d. Calculate the firm's profit or loss.- !;,-;:'7 e. IfAVC were $22 at the profit-maximizing level of output, would the firm produce in the short run? Explain why or why not. ND rL Ave.. 1 point: ATC is above price at the profit-maximizing output. 1 point: MC crosses ATC at the lowest point on ATC. 1 point: AVC is labeled and U-shaped. 1 point: AVC is below price at the profit-maximizing output. 1 point: Loss rectangle is correctly located and identified. section 5 8 Quantity of tomatoes (bushels) 1 point: Vertical axis is labeled "Price, cost of unit" or "Dollars per unit"; horizontal axis labeled "Quantity" or "Q." 1 point: ATC is labeled and U-shaped. 2 Market Structures: Perfect Competition and Monopoly Solutions appear at the back ofthe book. Check Your Understanding 1. Which of the following events will i'nduce firms to enter an industry? Which will induce firms to exit? When will entry or exit cease? Explain your answer. a. A technological advance lowers the fixed cost of production of every firm in the industry. b. The wages paid to workers in the industry go up for an extended period of time. c. A permanent change in consumer tastes increases demand for the good. d. The price of a key input rises due to a long-term shortage of that input. 2. Assume that the egg industry is perfectly competitive and is in long-run equilibrium with a perfectly elastic long-run industry supply curve. Health concerns about cholesterol then lead to a decrease in demand. Construct a figure similar to Figure 24.3, showing the short-run behavior of the industry and how long-run equilibrium is reestablished. Tackle the Test: Multiple-Choice Questions 1. In the long run, a perfectly competitive firm will earn a. a negative market return. b. a positive profit. c. a loss. normal profit. e. excess profit. (!). 2. With perfect competition, efficiency is generally attained in a. the short run but not the long run. �he long run but not the short run. c. both the short run and the long run. d. neither the short run nor the long run. e. specific firms only. 3. Compared to the short-run industry supply curve, the long-run industry supply curve will be more �astic. Yinelastic. c. steeply sloped. d. profitable. e. accurate. 4. Which of the following is generally true for p erfect competition? I. There is free entry and exit. II. Long-run market equilibrium is efficient. III. Firms maximize profits at the output level where P = MC. a. I only b. II only c. III only d. I and II only II, and III a::t\ 5. Which of the following will happen in response if perfectly competitive firms are earning positive economic profit? a. Firms will exit the industry. (E::rhe short-run industry supply curve will shift right. c. The short-run industry supply curve will shift left. d. Firm output will increase. e. Market price will increase. Market Structures: Perfect Competition and Monopoly Tackle the Test: Free-Response Questions 1. Draw a correctly labeled graph showing a perfectly competitive firm in long-run equilibrium. 2. Draw correctly labeled side-by-side graphs to show the long-run adjustment that would take place ifperfectly competitive firms were earning a profit. Answer (7 points) Price, cost 1 point Axes are correctly labeled. Q* Quantity 1 point: Demand curve is horizontal and labeled with some combination of" P," "MR,"or"D." 1 point: Marginal cost curve is labeled and slopes upward. 1 point: Profit-maximizing quantity is labeled on horizontal axis where MC= MR. 1 point: Average total cost curve is labeled and U-shaped. / / 1 point: Marginal cost curve crosses the average total cost curve at the lowesr' point on the average total cost curve .- / 1 point: Average total cost is equal to price at the profit-maximizing output ii J� 1 u:--. Q I mod u I e 24 Long-Run Outcomes in Perfect Competition S-16 SOLUTIONS TO AP REVIEW QUESTIONS b. The profit-maximizing quantity is 4. c. The firm's maximum profit is TR -TC= (4 x $14) - $56 = $56 - $56 = $0. Check Your Understanding Price, cost of unit MC ! P2 • • • • • • • • • • • • • • 0 Check Your Understanding L_---�-�------ a, a, Quantity a. The firm should shut down immediately when price is less than minimum average variable cost, the shut-down price. In the accompanying diagram, this is optimal for prices in the range from 0 to P1. b. When the price is greater than the minimum average variable cost (the shut-down price) but less than the minimum average total cost (the break-even price), the firm should continue to operate in the short run even though it is making a loss. This is optimal for prices in the range from P1 to P2 . c, When the price exceeds the minimum average total cost (the break-even price), the firm makes a profit. This hap­ pens for prices in excess of P2 • 2. This is an example of a temporary shut-down by a firm when the market price lies below the shut-down price, the minimum average variable cost. The market price is the price of a lobster meal and the variable cost is the cost of the lobster, employee wages, and other expenses that increase as more meals are served. In this example, however, it is the average variable cost curve rather than the market price that shifts over time, due to sea­ sonal changes in the cost of lobsters. Maine lobster shacks have relatively low average variable cost during the summer, when cheap Maine lobsters are available; during the rest of the year, their average variable cost is relatively high due to the high cost of imported lob­ sters. So the lobster shacks are open for business during the summer, when their minimum average variable cost lies below price; but they close during the rest of the year, when the price lies below their minimum average variable cost. Tackle the Test: Multiple-Choice Questions 1. e 2, 3. d b $20 x 6 = $120 $29.50 X 6 = $177 $120 -$177 = -$57 (or a loss of $57) No, because PAVC Module 24 P1 ' ' • ' • • �- ,-._ ---,/.�-� At prices below P1, the firm t _ shuts down immediately C b. C. d. e. At prices above P2, the firm t operates with a profit At prices above P1 and below P2, the firm operates in the short run with a loss d s. Tackle the Test: Free-Response Questions 2. a. 6 Module 23 1. 4. 1. a. A fall in the fixed cost of production generates a fall in the average total cost of production and, in the '.shbrt run, an increase in each firm's profit at the current output level. So in the long run new firms··wm enter the industry. The increase in supply drives down price and profits. Once pr9fits are driven back to zero, entry will cease. b. An increase in wages generates an increase in the aver­ age variable and the average total cost of production at every output level. In the short run, firms incur losses at the current output level, and so in the long run some firms will exit the industry. (If the average vari­ able cost rises sufficiently, some firms may even shut down in the short run;) As firms exit, supply decreases, pric� rises, and losses are reduced. Exit will cea�e once losses return to zero. c. Price will rise as a result of the increased demand, lead­ ing to a short-run increase in profits at the current out­ put level. In the long run, firms will enter the industry, generating an increase in supply, a fall in price, and a fall in profits. Once profits are driven back to zero, entry will cease. d. The shortage of a key input causes that input's price to increase, resulting in an increase in average vari­ able and average total cost for producers. Firms incur losses in the short run, and some firms will exit the industry in the long run. The fall in supply generates an increase in price and decreased losses. Exit will cease when the losses for remaining firms have returned to zero. 2. In the accompanying diagram, point XMKT in panel (b), the intersection of S1 and D11 represents the long-run industry equilibrium before the change in consumer tastes. When tastes change, demand falls and the industry moves in the short run to point YMKT in panel {b), at the intersection of the new demand curve D2 and S 11 the short-run supply curve represent­ ing the same number of egg producers as in the origi­ nal equilibrium at point XMKT' As the market price falls, each individual firm reacts by producing less-as shown in panel (a)-as long as the market price remains above the minimum average variable cost. If market pd�e falls below minimum average variable