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answers-11 - Answers to Questions for Review 1 Economic...

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Answers to Questions for Review 1. Economic profit includes all costs, while accounting profit looks only at cash flow. The firm should consider economic profit only. 2. Unless firms act as though their pricing decisions affect other firms, we should assume that firms act as price takers. 3. The dry cleaning markets would be nearly perfect except that many people do not want to drive far for their clothing pickups and dropoffs. In small towns there may only be one or two cleaners so less competition will be present. 4. Price = TR/Q, so this firm's demand curve is given by P=a - 2Q. Since its price is a declining function of output, it cannot be a perfectly competitive firm. 5. No, because managers often relate to their competition by trial and error actions moving in the direction of what succeeds for them. This moves the firm to the quantity of output that is consistent with perfect competition outcomes. 6. The firm should shut down if and only if its price is below AVC. MC can lie below AFC at the same time price lies above AVC (see diagram). So false. P Q P* Q* MC AVC AFC 7. The value of the last unit to consumers (the price) equals the opportunity cost of resources necessary to produce that unit. Or, in other words, the marginal benefit of the good to consumers equals the marginal cost of production. 8. The effect of such a tax is to produce a parallel upward movement in each firm's long-run average cost curve. The output level for which the minimum value of LAC occurs will thus be the same as before, which means that firms in long-run equilibrium will each have the same amount of output as before. So true. 9. A firm will have a long-run marginal cost function that is above average cost for all points past the minimum point on the long-run average cost curve. If demand causes price to be above the minimum average cost in the short-run, then firms could be operating where price equals long-run marginal cost and they could be making economic profits. When entry occurs in the long-run the price will fall and
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price will equal long-run marginal cost at the long-run equilibrium output level. Thus the statement is false. P LAC LMC SAC SMC P* $/Q Q Q* Q 0 0 10. Consumer surplus in a competitive industry is the area between the price line and the market demand curve, not the individual firm's demand curve. Since the market demand curve is downward sloping, there will in general be positive consumer surplus. Indeed, compared to other market structures, perfect competition creates the maximum consumer surplus. So false.
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