Question

6. Suppose firms in a perfectly competitive industry are experiencing economic profits. One can predict that the:

1. (a) market price will fall as more firms enter the industry.

2. (b) market price will rise further to take advantage of profitable opportunities.

3. (c) market price will stay the same.

4. (d) number of firms in the industry will not change.

5. (e) both (a) and (d).

7. When total revenue for a firm is more than the explicit costs:

1. (a) both accounting profit and economic profit are positive.

2. (b) accounting profit is positive and economic profit may be positive or negative.

3. (c) normal profit will be larger than zero.

4. (d) an economic profit must also occur.

5. (e) economic profit is negative but normal profit is positive.

8. Which of the following statements is TRUE?

1. (a) Economic profit is always the same as accounting profit.

2. (b) Normal profit indicates opportunity cost has been recovered.

3. (c) Accounting profit includes implicit costs.

4. (d) Economic profit only includes explicit costs.

5. (e) When accounting profit is positive, economic profits will always be positive.

9. Pete use to work for a small building company and earned $40,000 per year. He decided to work for himself and bought a fish and chip shop where he generated revenue of $120,000 in the first year. Rental, utility and supply costs for the business were $58,000 in the first year. Pete pays a part time book keeper $12,000 per year. Based on this information, Pete’s economic profit in the first year is:

1. (a) $80,000

2. (b) $58,000

3. (c) $50,000

4. (d) $28,000

5. (e) $10,000

10. For a profit maximising firm in a perfectly competitive industry in the short run:

1. (a) economic profit is always zero.

2. (b) economic profit may be positive, zero, or negative.

3. (c) price will be greater than marginal revenue.

4. (d) price will be less than marginal revenue.

5. (e) economic profit will never be positive.

Answer 1

6)

When firms in the perfect competitive industry earns positive profit and as there is no barriers to entry in perfect competitive industry, this attracts new firms and they starts entering. This shifts Industry supply curve to the right and which results in decrease in Price.

Hence the correct answer is (a) market price will fall as more firms enter the industry

7)

Accounting profit = Total revenue - Explicit Cost

Hence If Total revenue > Explicit Cost => Accounting profit > 0 i.e. positive

Economic profit = Total revenue - Explicit Cost - implicit cost

=> Economic profit = Accounting profit - implicit cost

If Accounting profit < implicit cost then Economic profit is negative and Accounting profit > implicit cost then Economic profit is positive.

Hence Economic profit can be positive or negative.

Hence the correct answer is (b) accounting profit is positive and economic profit may be positive or negative.

8)

Normal Profit means that Economic profit = 0

=> Economic profit = Total revenue - Explicit Cost - implicit cost = 0

=> Opportunity cost = Explicit Cost + implicit cost

=> Economic profit = Total revenue - Opportunity cost = 0

=> Total revenue + Opportunity cost

This means that Opportunity cost is recovered.

Hence the correct answer is (b) Normal profit indicates opportunity cost has been recovered.

9)

Explicit Cost = Supply cost + book keeper cost = 58000 + 12000 = 70000

Implicit cost = Income he sacrificed because of starting his new business(i.e. salary) = 40,000

Total revenue = 120,000

Hence Economic profit = Total revenue - Explicit Cost - implicit cost

= 120,000 - 70,000 - 40,000

= 10,000

Hence the correct answer is (e) $10,000

10)

In the short run If profit maximizing price is greater than Average Total Cost(ATC) then  profit maximizing firm in a perfectly competitive industry can earn positive profit

In the short run If profit maximizing price is lesser than Average Total Cost(ATC) and greater than Average Variable cost(AVC) then it will still produce. Then  profit maximizing firm in a perfectly competitive industry in the short run will earn negative profit

In the short run If profit maximizing price = Average Total Cost(ATC) then  profit maximizing firm in a perfectly competitive industry in the short run will earn 0 profit.

Hence the correct answer is (b) economic profit may be positive, zero, or negative

Note that Ina long run perfect competitive firm earn 0 profit only because in the long run If new firms enter and results in decrease in price till each firm starts earning 0 profit.