Chapter 14-17.doc - Chapter 14 SOLUTIONS TO TEXT PROBLEMS Quick Quizzes 1 When a competitive firm doubles the amount it sells the price remains the same

Chapter 14-17.doc - Chapter 14 SOLUTIONS TO TEXT PROBLEMS...

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Chapter 14: SOLUTIONS TO TEXT PROBLEMS: Quick Quizzes 1. When a competitive firm doubles the amount it sells, the price remains the same, so its total revenue doubles. 2. The price faced by a profit-maximizing firm is equal to its marginal cost because if price were above marginal cost, the firm could increase profits by increasing output, while if price were below marginal cost, the firm could increase profits by decreasing output. A profit-maximizing firm decides to shut down in the short run when price is less than average variable cost. In the long run, a firm will exit a market when price is less than average total cost. 3. In the long run, with free entry and exit, the price in the market is equal to both a firm’s marginal cost and its average total cost, as Figure 1 shows. The firm chooses its quantity so that marginal cost equals price; doing so ensures that the firm is maximizing its profit. In the long run, entry into and exit from the industry drive the price of the good to the minimum point on the average-total-cost curve. Figure 1 Questions for Review 1. A competitive firm is a firm in a market in which: (1) there are many buyers and many sellers in the market; (2) the goods offered by the various sellers are largely the same; and (3) usually firms can freely enter or exit the market. 2. Figure 2 shows the cost curves for a typical firm. For a given price (such as P * ), the level of output that maximizes profit is the output where marginal cost equals price ( Q * ), as long as price is greater than average variable cost at that point (in the short run), or greater than average total cost (in the long run). Figure 2 3. A firm will shut down temporarily if the revenue it would get from producing is less than the variable costs of production. This occurs if price is less than average variable cost. 4. A firm will exit a market if the revenue it would get if it stayed in business is less than its total cost. This occurs if price is less than average total cost. 5. A firm's price equals marginal cost in both the short run and the long run. In both the short run and the long run, price equals marginal revenue. The firm should increase output as long as marginal revenue exceeds marginal cost, and reduce output if marginal revenue is less than marginal cost. Profits are maximized when marginal revenue equals marginal cost.
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6. The firm's price equals the minimum of average total cost only in the long run. In the short run, price may be greater than average total cost, in which case the firm is making profits, or price may be less than average total cost, in which case the firm is making losses. But the situation is different in the long run. If firms are making profits, other firms will enter the industry, which will lower the price of the good. If firms are making losses, they will exit the industry, which will raise the price of the good. Entry or exit continues until firms are making neither profits nor losses. At that point, price equals average total cost.
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