# Answer Key 5 - Correct Answer False TRUE OR FALSE(You do...

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Correct Answer: False TRUE OR FALSE (You do not need to justify your answer but think of a justification) 1. A firm in a competitive industry takes account of the fact that the demand curve it confronts has a significant negative slope. FALSE, the firm is so small that from it’s point of view they face a flat demand curve. 2. Mr. O. Carr has the cost function c ( y ) = y 2 + 100 if his output, y , is positive and c (0) = 0. If the price of output is 25, Mr. Carr’s profit-maximizing output is zero. FALSE, he produces at P=MC so 25=2y and y*=12.5. Many ways of checking this, here is one: profit=P*y- c(y)=25*12.5 – (12.5*12.5) – 100 = 56.25 (not zero). 3. Two firms have the same technology and must pay the same wages for labor. They have identical factories, but firm 1 paid a higher price for its factory than firm 2 did. If they are both profit maximizers and have upward-sloping marginal cost curves, then we would expect firm 1 to have a higher output than firm 2. FALSE, since both will set P=MC and the marginal cost is not affected by the fixed cost they paid for the factory. That is, since the factories are identical they have the same cost structure so P=MC will give you the same level of output. 4. Average fixed costs never increase with output. TRUE, remember the fixed cost is just a number F, so AFC=F/y which will always decrease as y gets larger. Formally if we take the derivative of AFC with respect to y we get -F/y 2 , which assuming the fixed cost is positive will always be negative (so increasing y by a little will always decrease AFC). 5. It is possible to have an industry in which all firms make zero economic profits in long-run equilibrium. TRUE, actually that is pretty much what we expect will happen since zero economic profits is a condition for no entry of new firms. If there were positive economic profits we would expect new firms to enter the market until they drive them to zero. 6. If some firm in an industry has the production function F ( x , y ) = x 3/4 y 3/4 , where x and y are the only two inputs in producing the good, then that industry cannot be competitive in the long run. TRUE because this technology shows increasing returns to scale so I can always double my production, less than double my costs and increase my profits so I have an incentive to grow and grow. 7. Since a monopoly charges a price higher than marginal cost, it will produce an inefficient amount of output. TRUE, since we now from the welfare theorems that any efficient outcome can be represented as the solution to a competitive market and competitive markets set P=MC. Another way of stating this is that if P>MC then there are people willing to pay (given by price) more that what it costs to make the marginal unit so it is efficient to produce it and yet it is not. 8.

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