Question

10. A profit maximizing firm in a competitive market produces chairs. The firm, which is a price-taker, faces a price of $35 for its product. Its average variable cost is $24 and its average fixed cost is $9 at the quantity where marginal cost equals marginal revenue. In the short run, the firm
A. should raise the price of its product.
B. should lower the price of its product.
C. will experience losses but will continue to produce chairs.
D. will shut down and incur the total loss of its fixed costs.
E. will be earning both economic and accounting profits.

11. Profit maximizing firms enter a competitive market when they observe that
(x) price exceeds average total cost for existing firms in the market.
(y) total revenue for existing firms in the market exceeds their short-run variable costs.
(z) average revenue is more than average total cost for existing firms in the market.
A. (x), (y) and (z) B. (x) and (y) only
C. (x) and (z) only D. (y) and (z) only
E. (y) only

12. If all firms have the same cost structure in a competitive market with free entry and exit, then
A. the price of the product will differ across firms.
B. all firms will operate at their efficient scale in the short run.
C. all firms will operate at their efficient scale in the long run.
D. Both A and C are correct.
E. Both B and C are correct

Answer 1

10) P = 35

AVC = 24

AFC = 9

ATC = AVC + AFC = 24+9 = 33

P> ATC. Imply that there is scope for profit earning in perfect competitive setup. This can be done by lowering price until P = ATC. Thus the correct option is (B).

11) (x) is true because for P>ATC there will be profit while for P<ATC there will be loss thus firms will enter only when P>ATC.

(y) is incorrect. Because firms enter only when there are super normal profit that is greater than zero profit. Profit >0 if TR> SRTC. TVC is either Less than or equal (when TFC=0) to TC. But firms look for SRTC and not TVC. TVC is considered for the existing firms to make decision about continue production or shut down in short run.

(z) True : Firms look for TR>TC. Divide by Q on both sides: TR/Q>TC/Q implying Average Total Revenue > Average total cost. Thus (x) and (z) are correct. Option (c).

12) When firms are in a competitive setup with similar cost structure. The firms are price takers and operate at the efficient scale both in short run and long run. Therefore (E) is correct option