Which describes a market structure that meets the conditions of perfect competition?
Many firms sell identical products
✓
A few firms control most of the sales
Each firm sells a clearly different product
Legal barriers keep new firms from entering
Correct Answer
Many firms sell identical products
Perfect competition requires many buyers and sellers, identical products, complete information, and free entry and exit. A few firms control most of the sales describes oligopoly. Each firm sells a clearly different product describes differentiated products, not perfect competition. Legal barriers keep new firms from entering violates the free entry condition.
Category: Conditions of Perfect Competition
Question 2
A perfectly competitive wheat farmer asks a few cents more per bushel than the going market price. What does the model predict?
The farmer earns more on each bushel sold
The farmer loses all sales to rival farmers
✓
The farmer loses a few buyers but gains profit
The market price rises to match the farmer
Correct Answer
The farmer loses all sales to rival farmers
Because every farmer sells an identical product and buyers know the market price, no one will pay more than that price to one seller. The farmer earns more on each bushel sold is wrong because no bushels sell at the higher price. The farmer loses a few buyers but gains profit describes a firm with a downward-sloping demand curve, not a price taker. The market price rises to match the farmer is wrong because one small seller cannot move the market price.
Category: Price Takers
Question 3
Why does a perfectly competitive firm have no reason to charge less than the market price?
Rival firms would match any price cut at once
Prices below the market level are illegal
It can already sell all it wants at the market price
✓
Its sales would fall if it charged less
Correct Answer
It can already sell all it wants at the market price
A price taker faces a horizontal demand curve, so it can sell any quantity it chooses at the going price, and cutting price would only reduce revenue. Rival firms would match any price cut at once is not the reason; the firm gains nothing from cutting price even if no one matches. Prices below the market level are illegal is false. Its sales would fall if it charged less is backwards, since a lower price would not reduce the quantity buyers want.
Category: Price Takers
Question 4
Producing 200 units costs a price-taking firm an average of $6 per unit, and every unit sells for the $5 market price. What is the firm's total profit or loss?
A profit of $1,000
A loss of $1,200
A loss of $1
A loss of $200
✓
Correct Answer
A loss of $200
Profit equals (price - average total cost) x quantity: ($5 - $6) x 200 = -$200, a loss of $200. A profit of $1,000 is total revenue, which ignores costs. A loss of $1,200 treats total cost as the loss. A loss of $1 is the loss per unit, not the total.
Category: Profit and Loss
Question 5
To maximize profit, a perfectly competitive firm produces the quantity at which which condition holds?
Price equals marginal cost
✓
Price equals average variable cost
Total revenue reaches its highest level
Marginal cost reaches its lowest point
Correct Answer
Price equals marginal cost
For a price taker, marginal revenue equals price, so the profit-maximizing rule MR = MC becomes P = MC. Price equals average variable cost marks the shutdown point, not the best output. Total revenue reaches its highest level is wrong because revenue keeps rising with output while costs rise faster. Marginal cost reaches its lowest point ignores revenue entirely.
Category: Profit-Maximizing Output
Question 6
A perfectly competitive firm sells 100 units at a market price of $10. Its average total cost at that output is $7. What is its economic profit?
$1,000
$300
✓
$700
$3
Correct Answer
$300
Profit equals (price - average total cost) x quantity: ($10 - $7) x 100 = $300. $1,000 is total revenue. $700 is total cost. $3 is profit per unit, not total profit.
Category: Profit and Loss
Question 7
At its profit-maximizing output, a competitive firm's price is $5, its average total cost is $6, and its average variable cost is $4. What should the firm do in the short run?
Shut down, since price is below average total cost
Raise its price above the market price
Keep producing, since price covers average variable cost
✓
Exit at once to stop paying its fixed costs
Correct Answer
Keep producing, since price covers average variable cost
Price is between average variable cost and average total cost, so the firm loses money but covers all its variable costs and part of its fixed costs, losing less than if it shut down. Shut down, since price is below average total cost would leave it paying all of its fixed costs with no revenue. Raise its price above the market price would cost it all its sales. Exit at once to stop paying its fixed costs is impossible in the short run, when fixed costs must still be paid.
Category: Shutdown Decisions
Question 8
A yoga studio pays $10,000 a month in rent under a lease and $15,000 a month in other costs that it avoids by closing. It expects $12,000 a month in revenue. What should it do in the short run?
Stay open, losing $3,000 instead of $10,000
Stay open, earning a profit of $2,000
Shut down, which avoids any loss at all
Shut down, losing $10,000 instead of $13,000
✓
Correct Answer
Shut down, losing $10,000 instead of $13,000
Staying open gives revenue of $12,000 against total costs of $25,000, a loss of $13,000, while closing leaves only the $10,000 rent, a loss of $10,000. Revenue does not cover the $15,000 of variable costs, so closing loses less. Stay open, losing $3,000 instead of $10,000 forgets to include the rent. Stay open, earning a profit of $2,000 subtracts only the rent. Shut down, which avoids any loss at all ignores the rent that is still owed.
Category: Shutdown Decisions
Question 9
A perfectly competitive industry is in long-run equilibrium when market demand falls. What happens in the short run?
Price falls below average cost and firms take losses
✓
Price rises and firms earn economic profits
Price stays the same and each firm makes more
New firms enter to replace the lost demand
Correct Answer
Price falls below average cost and firms take losses
A decrease in demand lowers the market price, and since price had been at the bottom of average cost, firms now lose money. Price rises and firms earn economic profits describes an increase in demand. Price stays the same and each firm makes more ignores the drop in demand. New firms enter to replace the lost demand is backwards, since losses lead firms to leave, not enter.
Category: Long-Run Adjustment
Question 10
Which curve is a perfectly competitive firm's short-run supply curve?
Its average total cost curve above minimum marginal cost
Its marginal cost curve above minimum average variable cost
✓
Its average variable cost curve at every output
Its marginal revenue curve at the market price
Correct Answer
Its marginal cost curve above minimum average variable cost
At each price the firm produces where price equals marginal cost, but it shuts down if price is below minimum average variable cost, so its supply curve is the part of marginal cost above that point. Its average total cost curve above minimum marginal cost does not show the P = MC choices. Its average variable cost curve at every output is not how the firm picks quantity. Its marginal revenue curve at the market price is the demand the firm faces, not its supply.
Category: Short-Run Supply
Question 11
The price of a key input rises for a perfectly competitive firm. What does the model predict about the firm's marginal cost curve and its output at any given price?
It shifts down, so the firm produces more
It stays put, since the market sets price
It shifts up, so the firm produces less
✓
It becomes horizontal at the market price
Correct Answer
It shifts up, so the firm produces less
Higher input prices raise the cost of each extra unit, shifting marginal cost up and to the left, so at any price the P = MC quantity is smaller. It shifts down, so the firm produces more describes a fall in costs. It stays put, since the market sets price confuses the price the firm takes with its own costs. It becomes horizontal at the market price describes the firm's demand curve, not its costs.
Category: Short-Run Supply
Question 12
Firms in a perfectly competitive industry are earning economic profits. What does the model predict for the long run?
Firms leave, market supply falls, and price rises
Existing firms raise their prices to keep the profits
Market demand shifts left until the profits disappear
New firms enter, market supply rises, and price falls
✓
Correct Answer
New firms enter, market supply rises, and price falls
With free entry, profits attract new firms, which shifts market supply to the right and pushes price down until economic profit is zero. Firms leave, market supply falls, and price rises is the response to losses. Existing firms raise their prices to keep the profits is impossible for price takers. Market demand shifts left until the profits disappear is wrong because entry works through supply, not demand.
Category: Long-Run Adjustment
Question 13
Which condition holds for a perfectly competitive firm in long-run equilibrium?
Price = marginal cost = minimum average total cost
✓
Price is greater than average total cost
Marginal cost is greater than price
Price = minimum average variable cost
Correct Answer
Price = marginal cost = minimum average total cost
In the long run the firm still sets P = MC, and entry and exit push price to the bottom of average total cost, where marginal cost crosses it. Price is greater than average total cost would mean profits that attract entry. Marginal cost is greater than price means the firm is producing too much to maximize profit. Price = minimum average variable cost is the short-run shutdown point, where the firm loses money.
Category: Long-Run Equilibrium
Question 14
In a constant-cost industry, market demand increases and the industry fully adjusts in the long run. How does the new long-run price compare with the original price?
It is higher than before
It is the same as before
✓
It is lower than before
It equals the short-run peak price
Correct Answer
It is the same as before
In a constant-cost industry, new firms can buy inputs at unchanged prices, so entry continues until price returns to its original zero-profit level. It is higher than before describes an increasing-cost industry. It is lower than before describes a decreasing-cost industry. It equals the short-run peak price ignores the entry that pushes price back down.
Category: Long-Run Supply
Question 15
A competitive firm's price covers its average variable cost but not its average total cost, and conditions are not expected to improve. What does the model predict the firm will do in the long run?
Keep producing indefinitely
Expand its plant to earn profit
Exit the industry
✓
Charge more than the market price
Correct Answer
Exit the industry
Covering variable cost justifies staying open only in the short run, while fixed costs cannot be escaped. In the long run all costs can be avoided, so a firm with ongoing losses leaves. Keep producing indefinitely would mean accepting losses forever. Expand its plant to earn profit does not fix a market price below average cost. Charge more than the market price would cost a price taker all of its sales.
Category: Long-Run Adjustment
Question 16
Using total revenue and total cost curves, where is a perfectly competitive firm's profit-maximizing output?
Where total revenue is as large as possible
Where total cost is as small as possible
Where the two curves cross each other
Where the vertical gap of revenue over cost is largest
✓
Correct Answer
Where the vertical gap of revenue over cost is largest
Profit is total revenue minus total cost, so the best output is where revenue lies farthest above cost. Where total revenue is as large as possible would mean producing without limit, since revenue rises with every unit. Where total cost is as small as possible is zero output. Where the two curves cross each other is a point of zero profit.
Category: Profit-Maximizing Output
Question 17
A perfectly competitive firm produces a quantity at which the market price is greater than its marginal cost. To raise its profit, what should it do?
Increase its output
✓
Decrease its output
Raise its price
Shut down at once
Correct Answer
Increase its output
When price, which is marginal revenue, exceeds marginal cost, each extra unit adds more to revenue than to cost, so producing more raises profit until P = MC. Decrease its output would give up units that add to profit. Raise its price is not possible for a price taker. Shut down at once makes no sense when the next units are profitable.
Category: Profit-Maximizing Output
Question 18
A competitive firm faces a market price of $12. Its marginal cost is $8 for the 3rd unit, $11 for the 4th, $14 for the 5th, and $17 for the 6th. How many units maximize its profit?
5
4
✓
3
6
Correct Answer
4
The 4th unit adds $12 in revenue and $11 in cost, raising profit by $1, but the 5th adds $14 in cost, lowering profit by $2. So 4 units is best. 5 includes a unit that costs more than its price. 3 stops before a unit that still adds to profit. 6 includes two units that each cost more than the price.
Category: Profit-Maximizing Output
Question 19
In a perfectly competitive market, what determines the price each firm receives?
The costs of the largest firm in the market
Each firm's own average total cost
Market supply and market demand together
✓
An agreement among the firms in the market
Correct Answer
Market supply and market demand together
The price comes from the intersection of market supply and market demand, and each small firm simply takes it as given. The costs of the largest firm in the market do not set the price, since no firm is large enough to influence it. Each firm's own average total cost determines its profit, not the price. An agreement among the firms in the market would be collusion, which is not part of perfect competition.
Category: Price Takers
Question 20
The case that perfect competition is allocatively efficient rests on buyers' willingness to pay. What does willingness to pay depend on that limits this argument?
The number of firms selling
The level of each firm's fixed cost
The firm's shutdown point
The distribution of income
✓
Correct Answer
The distribution of income
People can only pay for what their incomes allow, so a person with little income may value a good highly and still be unable to buy it. An efficient outcome therefore reflects the existing distribution of income. The number of firms selling affects supply, not buyers' willingness to pay. The level of each firm's fixed cost is a cost concept. The firm's shutdown point is about when firms stop producing.
Category: Efficiency