Break-even and Profit Maximization in Perfect Competition

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Feb 20, 2024

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Additional questions Ch. 9 and 10 Q1 Assume that the given price = $25 per unit. Complete the table for answering the given questions. a) What is the Break-even level of output? TR=TC b) What is the Profit maximizing level of output? What is amount of maximum profit? TR-TC is highest c) What are the Levels of output where firm gets loss? Before Q= and after Q= d) What is the total fixed cost (TFC)? TC is given and output is 0 Atomistic price ( f irms get profit when TR>TC OR TR-TC>0 OR TR-TC is positive) Firms get loss when TR<TC Firm gets no loss no profit TR=TC Profits are maximum when TR-tc is maximum 1 Qty. TR TC Profits/ Loss 0 22 I 45 2 66 3 85 4 100 5 114 6 126 7 141 8 160 9 183 10 210 11 245 12 300 13 360

Q2 Following data are given regarding 1000 identical firms in the perfect competitive industry. Answer the questions given below the table. Price ($ per unit) Quantity supplied (by 1000 firms) Quantity supplied (by each firm) Total demand (industry) Average cost (Each firm) ($) 25 10000 10 4000 20 23 9000 9 6000 19 21 8000 8 8000 17 10 7000 7 9000 12 7 6000 6 11000 9 i) What will be the equilibrium output and price for the industry? ii) What will the total profit or loss for the industry? iii) What will be the profit or loss for each firm? iv) What will be per unit loss for each firm? v) Whether this industry will expand or contract in the long period? 2

3 Consider the following cost data for a perfectly competitive producer to answer the questions given below it. Q (UNITS) AFC ($) AVC ($) AC ($) MC ($) 0 ------ ------ ------ ------ 1 60 45 105 45 2 30 42.5 72.5 40 3 20 40 60 35 4 15 37.5 52.5 30 5 12 37 49 35 6 10 37.5 47.5 40 7 8.57 38.57 47.14 45 8 7.5 40.63 48.13 55 9 6.67 43.33 50 65 3

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10 6 46.5 52.5 75 i) What is the amount of TFC? ii) What is the amount of minimum AVC? Using the MC=MR Rule , answer the questions given in different scenarios: Scenario 1: i) Will this firm produce in the short run if the product price is $56 per unit? Why Q = TR = TC = Total profit = Profits per unit = Production decision: Scenario 2: ii) Will this firm produce in the short run if the product price is $41 per unit? Why? Q = TR = TC = Total loss = Loss per unit = Production decision: Scenario 3: iii) Will this firm produce in the short run if the product price is $32 per unit? Why? Q = TR = TC = Total loss = Loss per unit = Production decision: 4

Q4 Consider the following diagram related and answer the questions given below. Quantity = 125 Price = $50 ATC = $30 TR = TC = Total profit = Profit per unit = Shut down price = 5

Q5 If firms are losing money in a perfectly competitive industry, then in the long run this situation will shift the industry: A. demand curve to the right, and the market price will increase. B. supply curve to the left, and the market price will increase. C. supply curve to the right, and the market price will decrease. D. demand curve to the left, and the market price will decrease Q6 When a perfectly competitive firm is in long-run equilibrium, price is equal to: A. marginal cost, but may be greater or less than average cost. B. minimum of the average cost, and also to marginal cost. C. minimum average cost, but may be greater or less than marginal cost. D. marginal revenue, but may be greater or less than both average and marginal cost. Q7 Long-run competitive equilibrium: A. is realized only in constant-cost industries. B. will never change once it is realized. C. is not economically efficient. D. results in zero economic profits. Q8 When a perfectly competitive firm is in long-run equilibrium: A. marginal revenue equals marginal cost. B. price equals marginal cost. C. minimum average total cost equals price. D. all of these are true. Q9 If a perfectly competitive firm is producing at the MR = MC output level and earning an economic profit, then: A. the selling price for this firm is above the market equilibrium price. B. new firms will enter this market. C. some existing firms in this market will leave. D. there must be price fixing by the industry's firms. Q10 Which of the following statements is correct? A. Economic profits induce firms to enter an industry; losses encourage firms to leave. B. Economic profits induce firms to leave an industry; profits encourage firms to leave. 6

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C. Economic profits and losses have no significant impact on the growth or decline of an industry. D. Normal profits will cause an industry to expand. Q11 A constant-cost industry is one in which: A. a higher price per unit will not result in an increased output. B. if 100 units can be produced for $100, then 150 can be produced for $150, 200 for $200, and so forth. C. the demand curve and therefore the unit price and quantity sold seldom change. D. the total cost of producing 200 or 300 units is no greater than the cost of producing 100 units. Q12 The long-run supply curve would be perfectly elastic in: A. an increasing-cost industry. B. a decreasing-cost industry. C. a constant-cost industry. D. a variable-cost industry. Q13 Productive efficiency refers to: A. cost minimization, where P = minimum ATC. B. production, where P = MC. C. maximizing profits by producing where MR = MC. D. setting TR = TC. Q14 Resources are efficiently allocated when production occurs where: A. marginal cost equals average variable cost. B. price is equal to average revenue. C. price is equal to marginal cost. D. price is equal to average variable cost. 7

Q15 Refer to the diagram below. Line (2) and Line (1) reflects the long-run supply curve for: A. a constant cost industry and an increasing cost industry respectively B. a decreasing-cost industry and technologically progressive industry respectively C. an increasing-cost industry technologically advanced industry D. technologically progressive industry and a constant cost industry respectively Q16 Congestion of airports and airspace causes the airline industry to experience external A. diseconomies and have a long-run supply curve with positive slope B. economies and have a long-run supply curve with positive slope C. diseconomies and have a long-run supply curve with negative slope D. economies and have a long-run supply curve with negative slope Q17 Which of the following characterizes a perfectly competitive industry? A. Each firm produces a product slightly different from that of its competitors B. The industry demand curve is vertical C. The demand for each individual firm is perfectly elastic D. Each firm sets a different price. Q18 William runs a shop that sells cell phones. William is a perfect competitor and can sell each cell phone for a price of $600. The marginal cost of selling one cell phone a day is $400; the marginal cost of selling a secondcell phone is $500; and the marginal cost of selling a third cell 8

phone is $700. To maximize his profit, Paulshould sell A. two printers a day C. three printers a day B. more than three printers a day D. one printer a day Q19 Suppose firms in a perfectly competitive industry are suffering an economic loss. Over long period of time, A. some firms leave the industry, so the price falls and the economic loss decreases B. some firms leave the industry, so the price rises and the economic loss decreases C. other firms enter the industry, so the price falls and the economic loss decreases D. other firms enter the industry, so the price rises and the economic loss decreases Q20 Romeo's Chocolates is producing 155 boxes of chocolates a day. Romeo's marginal revenue and marginal cost curves are shown in the diagram above. Romeo should A. decrease output to increase profit B. maintain the current level of output to maximize profit C. increase output to increase profit D. Not enough information is given to determine if Romeo should increase, decrease, or not change his level of output Q21 True/ false. i) Firm gets maximum profits or minimum losses when MC = MR 9

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ii) vi) If the firm produces more units even when price is below the minimum AVC, its losses will be more than the TFC of the production i ii) Shut down point is the level of output where price equals the maximum AVC iv) At break-even level of output, TR<TC v) Short period supply curve will begin above the minimum level of AVC vi) In case MC = MR rule, the firm should produce the last complete unit of output for which MC exceeds MR (MC>MR) Q22 Use the following diagram to answer questions given below it. i)The profit-maximizing output level for this firm will be ... ...... ii)The amount of profit at profit maximizing level of output = iii) The break-even points are... iv) The firm will get losses when the output level is ……… Q23 The following figure shows the cost and revenue curves for a perfectly competitive firm. The firm represented by the diagram would maximize its profit by producing at the point where: 10

A. curves (2) and (1) intersect. B. curve (1) touches the horizontal axis for the second time. C. the vertical distance between curves (3) and (4) is the greatest. D. curves (3) and (4) intersect. Q24 The length of time constituting the long run: A. is about 2 years. B. varies substantially by industry. C. is the same for pretty well all industries. D. is about 5 years. Q25 A constant-cost industry is one in which: A. resource prices fall as output is increased. B. resource prices rise as output is increased. C. resource prices remain unchanged as output is increased. D. small and large levels of output entail the same total costs. Q26 These diagrams, pertain to a perfectly competitive firm producing output q and the industry in which it operates. In the long run we should expect: 11

A. firms to enter the industry, market supply to rise, and product price to fall. B. firms to leave the industry, market supply to rise, and product price to fall. C. firms to leave the industry, market supply to fall, and product price to rise. D. no change in the number of firms in this industry. Q27 The long-run supply curve would be perfectly elastic in: A. an increasing-cost industry. B. a decreasing-cost industry. C. a constant-cost industry. D. a variable-cost industry. Q28 Assume a perfectly competitive firm in long-run equilibrium is producing 10,000 units of output that is sold at a price of $40 per unit. Which of the following outcomes indicates that the industry is an increasing-cost industry? A. A decline in demand increases the price to $45 and reduces the output to 9,000 units. B. An increase in demand increases the price to $50 and increases the output to 15,000 units. 12

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C. A decline in demand decreases the price to $35 and increases the output to 15,000 units. D. An increase in demand increases the price to $45 and reduces the output to 9,000 units. Solution hints: Q1 a) Qty. 4 & 12 b) Qty. = 9 c) 12<Q<4 d) $22 Q2 i) Output = 8000 units Price = $21 ii) $3200 iii) $32 iv) $4 v) Expand Q3 i) $60 ii) $37 Scenario 1 i) Q = 8 Profit per unit = $7.87 Prod. Decision: yes…. Scenario 2 i) Q = 6 Loss per unit = $6.5 Prod. Decision: yes…. Scenario 3 i) Q = 4 Loss per unit = $20.5 Prod. Decision: Shut down…. Q4 Output units = 125 Profit per unit = $20 Q5 B Q6B Q7D Q8D Q9B Q10A Q11B Q12C Q13A Q14C Q15A Q16A Q17C Q18A Q19B Q20A Q21 i), iii) and v) are true statements Q22 i) Q3 ii) de iii) a and f iv) less than Q1 and more than Q4 Q23 C Q24B Q25C Q26C Q27C Q28B {Note: Don’t cram the answers. Understand the logic. Complete all the calculations. Contact if guidance/help required.} Self-reading segments: Running a Company Is Hard Business 13

The life expectancy of a Canadian business is just 10.2 years. About 9.5 percent of Canadian firms go out of business each year. In addition, 22 percent of startup firms go bankrupt within two years, 53 percent within five years, and nearly 65 percent within ten years. These numbers testify to the ability of competition to quickly dispose of firms that have high production costs or unpopular products. In a competitive environment, such firms quickly prove unprofitable and are shut down by their owners. For example, BlackBerry, once one of Canada's outstanding successes, has recently lost market share due to the relentless competition from Apple's iPhone and cellphones running Google's Android operating system. Balancing out the dying firms are startups that hope to use the resources freed up by the closed firms to deliver better products or lower costs. In a typical year, more than 65,000 new businesses are started in Canada. Most of these new firms will themselves eventually fall victim to creative destruction and the pressures of competition, but it's also possible that one of them will be the next Apple or Tim Hortons. Creative Destruction: The innovations that firms achieve thanks to competition are considered by many economists to be the driving force behind economic growth and rising living standards. The transformative effects of competition are often referred to as creative destruction to capture the idea that the creation of new products and new 14

production methods destroys the market positions of firms committed to existing products and old ways of doing business. In addition, just the threat that a rival may soon come out with a new technology or product can cause other firms to innovate and thereby replace or rectify their old ways of doing business. As argued many years ago by Harvard economist Joseph Schumpeter, the most important type of competition is . . . competition from the new commodity, the new technology, the new source of supply, the new type of business organization—competition which commands a decisive cost or quality advantage and which strikes not at the margins of profits of the existing firms but at their foundation and their very lives. This kind of competition is . . . so . . . important that it becomes a matter of comparative indifference whether competition in the ordinary [short-run or long-run] sense functions more or less promptly. . . competition of the kind we now have in mind acts not only when in being but also when it is merely an ever-present threat. It disciplines before it attacks. The businessman feels himself to be in a competitive situation even if he is alone in his field. 2 There are many examples of creative destruction. In the 1800s wagons, ships, and barges were the only means of transporting freight until the railroads broke up their monopoly; the dominant market position of the railroads was, in turn, undermined by trucks and, later, by airplanes. Movies brought new competition to live theatre, at one time the “only show in town.” But movies were later challenged by broadcast television, which was then challenged by cable TV. Both are now challenged by Netflix, Amazon Instant Video, and other online video-on-demand services. Cassettes replaced records before compact discs undermined cassettes. Now iPods, MP3 players, and Internet music downloads will soon make the compact disc obsolete. Electronic communications—including faxes and emails—have greatly affected Canada Post. And online retailers like Amazon.com have stolen substantial business away from bricks-and-mortar retailers. The “creative” part of creative destruction leads to new products and lower-cost production methods that are of great benefit to society because they allow for a more efficient use of society's scarce resources. Keep in mind, however, that the “destruction” part of creative destruction can be very hard on workers in the industries being displaced by new technologies. A worker at a CD-making factory may see her job eliminated as consumers switch to online music downloads. Canada Post cut hundreds of jobs in 2011 partly due to the impact that email has had on the demand for postal services. We need fewer and fewer postal workers each year thanks to email and texting. And many jobs in retail have been eliminated due to competition with Amazon.com and other online retailers. Normally, the process of creative destruction goes slowly enough that workers at firms being downsized can transition smoothly to jobs in firms that are expanding. But sometimes the change is too swift for all of them to find new jobs easily. And in other instances, such as a town with only one major employer—like a rural coal-mining town or a small town with a large auto factory—the loss of that one major employer can be 15

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devastating because there are not enough other firms in the local area to employ the workers laid off by the major employer. While the net effects of creative destruction are indisputably positive—including ongoing economic growth, and rising living standards—creative destruction involves costs as well as benefits. And while the benefits are widespread, the costs tend to be borne almost entirely by the relatively few workers in declining industries who are not positioned to make easy transitions to new jobs. 16

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