Deck 13: Perfect Competition

Question 1

A perfectly competitive market is a market in which economic forces operate unimpeded. The six conditions necessary to have a perfectly competitive market are: (1.) Both buyers and sellers are price takers. (2.) The number of firms is large. (3.) There are no barriers to entry. (4.) Firms' products are identical. (5.) There is complete information. And (6.) selling firms are profit maximizing entrepreneurial firms. Discuss any three of these conditions.

Answer 1

(Any three of the following)
1. In a perfectly competitive industry both buyers and sellers are price takers. Price takers are firms or individuals who take the price determined by the market equilibrium as given. In a perfectly competitive market, market supply and demand determine the price; both firms and consumers take the price as given.
2. A large number of firms in this context means that there are so many firms that any one firm's output compared to market output is imperceptible, and what one firm does has no influence on what other firms do.
3. There are no barriers to entry. Barriers to entry may be social, political or economic impediments that prevent firms from entering a market. In a perfectly competitive industry, there could be no patents, and the minimum efficient scale should allow a large number of firms to produce at the lowest average cost.
4. Each firm's output is indistinguishable from any other firm's output. Corn sold on national grain markets would be an example. The price of all bushels would be the same. Pepsi and Coke are examples of products that are not identical. They may sell at different prices in the market and the market for colas and therefore cannot be regarded as perfectly competitive.
5. In a perfectly competitive market, firms and consumers know all there is to know about the market. This would include prices, products and available technology. Thus no firm or consumer would have a competitive edge over another.
6. For perfect competition to exist, firms must seek maximum profit and only profit, and the people who make the firm's decisions must receive profit and only profit.

Question 2

Demonstrate graphically and explain verbally how a demand curve facing a perfectly competitive firm relates to the market demand curve.

Answer 2

The demand curve facing a perfectly competitive firm is perfectly elastic at the price level that is determined by the equilibrium of the market demand and market supply curves. This can be illustrated as follows:

Question 3

How does a market supply curve relate to a firm's supply curve?

Answer 3

A market supply curve is the horizontal summation of all the firms' marginal cost curves, taking into account any changes in input prices that might occur.

Question 4

In determining the supply curve of a perfectly competitive firm, what cost information do you need? Explain.

Question 5

Retail stores generally set a fixed price and let people buy all they want at that price. Does that mean that the supply curve of those goods is perfectly elastic?

Question 6

How are normal profits related to economic profits?

Question 7

Firms know that when they enter a profitable industry, profits will eventually be eliminated by competition. Why would a firm want to enter such an industry?

Question 8

Explain, using an example if necessary to be clear, why the minimum point on the average variable cost curve is the shutdown point. In other words, why is a competitive firm's supply curve that portion of the marginal cost curve that lies above the minimum average variable cost?

Question 9

In determining the supply curve of a perfectly competitive firm, what cost information do you need? Why do you need that information? Explain.

Question 10

Explain how the long-run market supply curve for a perfectly competitive industry depends upon factor prices.

Question 11

Perfectly competitive firms are price takers. However, in the real world, it is rare that the customer goes into any business establishment and tells the seller what price he is willing to pay. Since buyers don't dictate price, where does price come from in perfectly competitive markets?

Question 12

Some firms, particularly but not exclusively Japanese firms, have historically considered their workers to be lifetime employees. Let's call these firms Type A firms. How would this management attitude affect Type A firms' production decisions during a period of slack demand and falling prices relative to other (Type
B) firms?

Question 13

Which of the necessary conditions for perfect competition are least likely to be satisfied in the real world? Explain your selections.

Question 14

Explain how the long-run market supply curve for a perfectly competitive industry depends upon factor prices. How would this apply to the milk producing industry?

Question 15

How does the Internet affect the competitive nature of markets?

Question 16

Why will perfectly competitive firms make zero profits in the long run? How are normal profits related to economic profits?

Question 17

How would an economist determine graphically the output and profit of a perfect competitor?

Question 18

Describe how a market supply curve relates to a firm's supply curve. How does the short-run market supply curve differ from the long run market supply curve?

Question 19

You are running a business in a perfectly competitive market. Your product sells for $5 and your marginal costs rise as output rises. What should you do in the two situations described below? What general rule do the above examples suggest about how a firm should determine the level of output to produce so as to maximize profit?
(a) The additional cost of producing another unit of output is $4. What should you do? What will this do to your total profit?
(b) The additional cost incurred from your last unit of output produced is $6. What should you do? What will this do to your total profit?
(c) What general rule do the above examples suggest about how a firm should determine the level of output to produce so as to maximize profit?

Question 20

Define a perfectly competitive market, and list the six conditions necessary for a market to be perfectly competitive.

Question 21

Consider the following table of numbers, which represents demand and cost conditions for a competitive firm.
(a) Fill in the missing values.
(b) What level of output should the firm produce? Explain.

Question 22

Using a supply and demand and a typical firm diagram, illustrate the impact of a flood on the market for contractors once the flood has receded. NOTE: Assume the market was perfectly competitive and in a long-run equilibrium position before the flood. Also assume that construction is a constant-cost industry.

Question 23

Using the following diagram, demonstrate graphically and explain verbally why Q₀ is not a profit maximizing output level.

Question 24

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 $50. (a) Fill in the missing values.
(b) What level of output should the firm produces? Why?
(c) What do you predict will happen to the number of firms in the industry? Why?
(d) What do you predict will happen to supply and the market price?
(e) At which price must the firm shut down?

Question 25

Using the following diagram, demonstrate that producing at the level of output associated with maximum per unit profit (minimum of the ATC curve) does not maximize total profit.

Question 26

Consider the following table of numbers, which represents demand and cost conditions for a competitive firm. What output level should the firm produce? Explain. NOTE: Marginal values represent values between levels of output. For example, the marginal cost between 0 units and 1 unit is $240.

Question 27

Consider the following diagram: Would a perfectly competitive firm facing these conditions stay in business in the short run? Demonstrate your answer by comparing the loss if it stayed open to the loss if it closed.

Question 28

Study the graph below and answer the following questions. (a) Is this firm making profit by producing 500 units in the short run? Why or why not?
(b) What will happen in the long run in this industry?
(c) Will the firm survive in this industry?

Question 29

Demonstrate graphically and explain verbally how a perfectly competitive firm's MC curve is its supply curve.

Question 30

Demonstrate graphically and explain verbally the case of a constant-cost industry in a perfectly competitive market. Draw both a firm and a market diagram. HINT: The long-run market supply curve in your diagram should be perfectly elastic (i.e., horizontal).

Question 31

The American Widget Corporation (AWC) is a profit-maximizing and perfectly competitive firm that is currently experiencing a loss. However, the market price of widgets is expected to increase in the near future. The company's vice-president, Alan R. ("Big Tuna") Burns, has recommended against increasing output in response to a higher price for widgets. His argument is that the marginal cost of the additional units of output will increase, and these higher costs will worsen AWC's losses. Evaluate this argument using an appropriate picture.

Question 32

Demonstrate graphically and explain verbally where the level of output should be when a perfectly competitive firm is earning a positive economic profit. Be sure to label the profit maximizing level of output and shade in the area that represents profit.

Question 33

Using the following diagram, demonstrate graphically and explain verbally why any movement away from output level Q₀ would decrease the firm's profit.

Question 34

Demonstrate graphically and explain verbally a perfectly competitive firms' long run equilibrium situation (be sure to show the long-run average total cost curve, short-run average total cost curve, marginal curve, and marginal revenue curve).

Question 35

Consider the following diagram of a representative competitive firm: Is this a long-run equilibrium situation? If yes, explain why it is. If no, explain what will happen to transform it into a long-run equilibrium situation.