ECON MICRO 105 Final Exam Study Guide

Econ 105

Final Exam Study Guide

   I.  True false questions. Briefly explain your answer to receive full credit.

  A.  Perfect Competition.

    1 .Perfectly competitive firm faces the law of demand

   2.  Because only perfectly competitive firms are price takers, only competitive firms can earn profits.

   3. To maximize profit, a perfectly competitive firm should produce the level of output at which

       marginal cost equals price.

   4.  A perfectly competitive firm is profitable when price exceeds minimum AVC

  5.  A competitive firm’s supply curve is just its MC curve.

  6.  A firm maximizes profit by producing where average total cost is at its minimum.

  7.  A firm will stay in business in the long run as long as price is greater than or equal to ATC.

  8.  The existence of losses in an industry means that some firms will leave the industry in the

  long- run.

 9. Since a firm in perfectly competitive market is a price searcher, it must lower price to sell an additional unit of its product.

 10. Perfectly competitive firm engages in a heavy advertising to increase its total revenue and profit

 11. Perfectly competitive firm marginal revenue is less then price the firm charges.

 12. Perfectly competitive firm engages in non-price competition

       B. Monopoly

       1. For a market to be a monopoly, there must be a large number of firms in the market and an identical product.

      2.  Since a monopolist is a price taker, it cannot have a supply curve.

     3. Since the monopolist's marginal revenue is below its price, its equilibrium output is the same as a perfectly competitive firm.

     4.   Because a monopoly is the only firm in an industry, it can charge any price it wishes.

     5. A profit-maximizing monopolist will always set price above marginal cost.

     6.   Long-run equilibrium for a monopoly is where economic profit is equal to zero.

      7.   The social cost of monopolies is measured by the deadweight loss associated with monopolies.    

      8.  In the long-run equilibrium monopoly produces at the minimum of ATC, therefore exhibits productive efficiency

     9.  In the long-run equilibrium monopoly firm exhibits allocative efficiency since produce the profit maximizing level of output where P = MC

      10.  Monopoly firm produces and sells identical product

      11.  Monopoly firm supply curve is a part of its marginal cost curve above minimum of AVC

      12. The monopoly engages in no-price competition.

     C. Monopolistic Competition.

       1. A monopolistically competitive industry is characterized by few sellers in a highly competitive market.

       2. In monopolistically competitive industry firms monopoly power comes from producing an identical product

      3.   It is relatively easy for new firms to enter a monopolistically competitive industry.

      4.   A monopolistically competitive firm faces a horizontal demand curve because of relatively large number of sellers in the market. 

      5.   When a monopolistically competitive firm is in a long-run equilibrium, average total cost is at minimum.

     6.   A profit maximizing, monopolistically competitive firm will produce the quantity of output at which price equals to marginal cost.

     7. The only way for a monopolistic competitor to increase its sales is to lower its price.

     8.  Monopolistically competitive firms earn their economic profits with barriers to entry

     9.  Monopolistically competitive firms are efficient because in the long run price falls to equal marginal cost.

    10. In a long-run monopolistic competitor can earn positive economic profit

   11. In the long-run equilibrium monopolistic competitor exhibits allocative and productive

    efficiency.

    12. Monopolistically competitive firms engage in price competition

   13. Monopolistically competitive firm does not engage in advertising because product under

       this market structure is an identical.

    14. The goal of product differentiation is to postpone the condition of the zero economic profit

     15. The benefit of monopolistically competitive market is variety of product, the cost is an

     increase in market efficiency.

    II. Short answer questions section.

 1. Discuss the following statement; “Economists need to pay more attention to the real world business. Their model of perfect competition predicts that firms in the market will end up earning no profit, nothing above costs. As any accountant can tell you, if you look at the balance sheet of most businesses in any industry, their revenue exceeds their costs, they do in fact make a profit.

2.  Explain what is the fundamental characteristic that distinguishes the short-run from long-run in production process?

3. Explain what is the fundamental characteristic that distinguishes the short-run from long-run of perfectly competitive market?

4. It is suggested that perfectly competitive firms are price takers. Although one rarely, if ever, has an opportunity to test this in the real-world, it is equally rare that the customer goes into any business establishment and tells the seller what the price is. If sellers are price takers and buyers don't dictate price, where does price come from in perfectly competitive markets?  Explain

5. Is this a long-run competitive equilibrium situation? If yes, explain why. If no, explain what will happen to transform it into a long-run equilibrium?

6.  Suppose you decided to open a copy store. You rent store space (signing a one year lease), and you take out a loan at the local bank and use the money to purchase 10 copiers. Six month later a large chain opens a copy store two blocks away from yours. As a result, the revenue you receive from your copy store, while sufficient to cover the wages of your employees, and the cost of paper and utilities, does not cover all of your rent and the interest rate and repayment costs on the loan you took out to purchase the copiers. Should you continue operating your business? Explain

7. Suppose there are three pizza places in your town. One of them has a “For sale” and a “Closed” sign in its window. The second has s “For sale “sign and “Open” sign in its window. The third one has only “Open “sign. Assuming that there is one going price for pizza in your town, what can you say about the costs of these three firms and their short-run and the long-run situations?

8. Zero economic profit includes a normal return for business owner. However, how do we know that the business owner will be satisfied with zero economic profit? In other words, if a business owner is earning zero economic profit, is there another opportunity out there that might offer a positive economic profit? If so, will the business owner leave the zero profit industry to pursue the positive economic profit?

9.  There are many wheat farms in the world, but there are also many Starbucks coffeehouses. Why, then, does Starbucks coffeehouse face a downward sloping demand curve when the wheat farmer faces a horizontal demand curve? Explain

10. Is it possible for marginal revenue to be negative for a firm selling in a perfectly competitive market? Would a firm selling in monopolistically competitive market ever produce where marginal revenue is negative? Explain

11. Explain why do monopolies arise? Discuss the most common factors that explain the existence of monopoly.

12. Recall that the law of demand states more of a good will be purchased the lower its price, other things constant. Explain why monopoly firms see this law in action but perfectly competitive firms do not.

13. Why might a monopoly earn an economic profit in the long-run? How does it differ from the situation faced by a perfectly competitive firm? Explain

14. Suppose that government agency imposes price ceiling on a monopoly product at the socially optimal price. Describe the effects of this regulation on a monopoly output, price, consumer’s surplus and market efficiency.

15. Grocery stores and gasoline stations in a large city would appear to be examples of perfectly competitive markets: There are numerous relatively small sellers, each seller is a price taker, and products are quite similar.  How could you argue that these markets are not perfectly competitive? Explain.

16. In long-run equilibrium in both perfect competition and monopolistic competition there is zero economic profit and yet the two cases are not identical. What is the key difference between them?

17. In what ways is monopolistic competition different from perfect competition? In what ways are they alike? What do buyers gain? What do buyers sacrifice under each market?

18. Monopolistic markets spend a relatively high share of its total revenue on advertising. Explain why. What are the goals of advertising under this market structure?

IV.            Problems solving

1. Econman has been infected by the free enterprise bug. He sets up a firm on extraterrestrial affairs. The rent of the building is $4,000, the cost of the two secretaries is $40,000, and the cost of electricity and gas comes to $5,000. There is great demand for his information, and his total revenue amounts to $100,000. By working in the firm, Econman forfeits the $50,000 he could earn by working for the Friendly Space Agency and the $4,000 he could have earned as interest rate had he saved his funds instead putting them in his business.

a. Calculate accounting cost for Econman enterprise.

b. Calculate economic cost for Econman enterprise.

d. Calculate accounting and economic profit for Econman enterprise. Do they differ? Why?

e. Should Econman stay in his business or not? Explain

2. You own four firms that produce different products.  The following table summarizes the conditions in each firm

Firm

P

MR

TR

Q

TC

MC

ATC

AVC

A

11

8

20

200

5

9

B

3                                                                

1

100

1.5

2.5

2

C

4

2

200

2

7

5

D

8

5

10

70

5

6

After calculating the missing numbers for each firm, make one of the following four decisions regarding operations in each firm, and explain why a particular decision is reached.

(a) Which firm should continue producing the same level of output in the short-run? Why?

(b) Which firm should shut down in the short-run and why?

(c)Which firm should increase its output to maximize profit in the short-run? Why?

(d)  Which firm should decrease its output to maximize profit in the short-run? Why?

3. Consider the following table of numbers, which represents demand and cost conditions for a competitive firm.  The price of the product this firm produces is $60.

Q

TFC

MC

TVC

TC

TR

MR

Total Profit

0

20

0

20

1

20

40

2

30

70

3

40

110

4

50

160

5

60

220

6

70

290

(a)    Fill in the missing values.

(b)   Does the table represent short-run in the production or long-run? Why

(c)    Is the Law of Diminishing Return present? Why yes, why not?

(d)   What level of output should the firm produce to maximize profit? Why?

(e)    What is the price elasticity of demand for this firm product equal to?

(f)    Calculate the firm profit/loss

(g)   What do you predict will happen in the long-run? Why?

(h)   What do you predict will happen to supply and the market price in the long-run?

4. These are the cost curves for a perfectly competitive firm. All underlying work must be shown

The market price is $5

a.      How many units of output should the firm produce to maximize profit? Why?

      b. The price elasticity of demand for this firm product equals_________, why?

     c .Calculate the firm’s total revenue at the profit maximizing level of output. 

     d. Calculate the firm’s total cost at the profit maximizing level of output 

     e. How much in profit/loss does the firm earn?

     f. What do you predict will happen to the number of firms in the long-run? Why

     g. How many units of output will the firm produce in the long-run competitive equilibrium and

     at what price will the firm sell them in the market?

     h. In the long-run competitive equilibrium, will the firm have incentive to exit the industry?

      Why yes, why not?

5. These are the cost curves for a perfectly competitive firm. All underlying work must be shown

The price of product is $3.

a. The firm produces at the price of $3 ________ units of output. Why?

b. The firm earns total revenue of:

c. The firm’s total cost at the profit maximizing level of output is 

d. The firm makes a profit (loss) of? Calculate the total profit or loss

e. Will the firm operate or shut down in the short run? Why?

f. If the firm shuts down in the short-run, what would be the amount of the total loss equal to?

 Calculate the dollar amount of the total loss.

g. What do you predict will happen to the number of firms in the long-run? To the industry output

 and price and output? Why?

6. Use the following to answer questions. Show all underlying work to earn full credit.

    Please, be careful with the quantity axis, draw the quantity lines properly

      a. Refer to the graph above. A profit-maximizing monopolist would produce______ units. Why?

      b. Refer to the graph above. A profit-maximizing monopolist would charge a price of:

c .Refer to the graph above. A profit-maximizing monopolist would earn total profit of?

Calculate the total profit

d. If the firm above is making positive economic profit, what will happen in long-run? Explain

e. Refer to the graph above. The dollar reduction in the market efficiency would be equal to the amount of:

      f. Refer to the graph above. If this industry were perfectly competitive, the long-run competitive equilibrium price and quantity would be:

    g. Refer to the graph above. If this industry were perfectly competitive, the social cost loss would be equal to__________

    h. If the government agency would regulate this firm and the industry above imposing the price

       ceiling at the socially optimal price, the firm would charge the price of_______  and  would

       produce ___________units,  market efficiency would ____________ by amount  of $____ 

    i. If the government agency would regulate this firm and the industry above imposing price

        ceiling at the fair- return price, the firm would charge the price of______  would produce ___________units and earn profit of ________?

7. The table below shows the demand and cost data facing “Velvet Touches” a monopolistically competitive producer of velvet throw pillows. Use the data to answer the following questions

Q           Price             TR             MR      Total Cost       Marginal Cost

1              30                30                             32

2              28                56                             43

3              26                78                             53

4              24                96                             64

5              22               110                            76

6              20               120                            90

7              18               126                           106

8              16               128                           126

a.      What level of output should the firm produce to maximize profit?

b.      What price should the firm charge per one pillow?

c.      Is the firm making a profit or loss and how much?

      d.   How “Velvet Touches” increase its profits in the short-run?   

      e.   If the Velvet Touches fixed cost increases by $10, how many pillows would the Velvet

            Touches produce? How much in profit would it earn?                  

      f. What do you predict is likely to happen in the long-run?

      g. Will there be more or less firms in market for decorative pillows? Explain your answer

8. The El Dorado Star is the only newspaper in El Dorado, New Mexico. Certainly, the Star competes with The Wall Street Journal, USA Today, and The New York Times for national news reporting, but the Star offers readers stories of local interest, such as local news, weather, sporting events, and so on. The El Dorado Star faces the revenue and cost schedule shown in the table below. All underlying work must be shown

Number of                    Total revenue            Total

Newspapers per day                                        cost

    0                                      $0                       $2,000

   1,000                               1,500                     2,100

   2,000                               2,500                     2,200

   3,000                               3,000                     2, 360

   4,000                               3,250                     2,520

   5,000                               3,450                     2,700

   6,000                               3,625                     2,890

   7,000                               3,725                     3,090

   8,000                               3,625                     3,310

   9,000                               3,475                     3,550

a. Is El Dorado operating in short-run or in long-run? Explain why.

b. How many papers should the manager of the El Dorado print and sell daily? Why?

c. How much profit (or loss) would the Star earn?

d. If fixed cost increases to $5,000, how many papers should be printed and sold in short run? What price would be charged?

f. What would the firm profit be?

g. What should the owners of the Star do in long-run? Explain.

9. The following table represents the market for Corning Fiberglass. Corning is the sole (single) producer of fiberglass.

Q               Price          TC                TR            MR                MC               

0                   50            60                  0

1                   46            65                  46

2                   42            81                  84

3                   38            111                114

4                   34            145                136

5                   30            189                150

6                   24            249                144

a. Does the table show short-run or long-run in the production? Why

b. Given the table above, are economies of scale present? Why yes, why not?

c. Refer to the table above, how many units of output should Corning Fiberglass produce to maximize profit? Why?

d. Refer to the table above, what price should Corning Fiberglass charge to maximize profit? 

 e. Calculate Corning Fiberglass firm total profit

f. What do you predict will happen in the long-run to the Corning Fiberglass profit?

g. Does the market for fiberglass exhibit allocative efficiency? Why yes, why not?