1. (Demand Under Perfect Competition) What type of demand curve does a perfectly
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Question
1. (Demand Under Perfect Competition) What type of demand curve does a perfectly competitive firm face? Why?
2. Explain the different options a firm has to minimize losses in the short run.
3. (The Short-Run Firm Supply Curve) Each of the following situations could exist for a firm in the short run. In each case, indicate whether the firm should produce in the short run or shut down in the short run, or whether additional information is needed to determine what it should do in the short run
a. Total cost exceeds total revenue at all output levels.
b. Total variable cost exceeds total revenue at all output levels.
4. (The Long-Run Industry Supply Curve) A normal good is being produced in a constant-cost, perfectly competitive industry. Initially, each firm is in long-run equilibrium. Briefly explain the short-run adjustments for the market and the firm to a decrease in consumer incomes. What happens to output levels, prices, profits, and the number of firms?
5. (Long-Run Industry Supply) Why does the long-run industry supply curve for an increasing-cost industry slope upward? What causes the increasing costs in an increasing-cost industry?
6. The National Council of Economic Education’s EconEdLink has an interesting module on the economics of Internet access at http://www.econedlink.org/teacher-lesson/10 Please review the materials provided. Is provision of Internet access a competitive industry? Briefly discuss.
7. Commodities like gold often trade in markets that are examples of perfect competition. Think a commodity that you believe trades in a perfectly competitive market, and describe why you believe this is so.
8. (The Short-Run Firm Supply Curve) An individual competitive firm’s short-run supply curve is the portion of its marginal cost curve that equals or rises above the average variable cost. Explain why.
9. What are the major characteristics of perfectly competitive market?
10. (Perfect Competition and Efficiency) Define productive efficiency and allocative efficiency. What conditions must be met to achieve them?
Explanation / Answer
(1)
A competitive firm is a price taker. It has to sell at the price that is determined by market demand and supply forces. Therefore, demand curve for a perfectly competitive firm is a horizontal straight line that is equal to its price equal to its marginal and average revenue (demand).
(2)
In the short run, losses occur if price is lower than the average total cost (ATC).
If the firm decides to operate in the sort run, it can either increase price or lower average total cost. Since a price taker firm cannot hike price, it can only lower its ATC by trying to reduce fixed costs, investing in technology enhancement or by looking for cheaper supply of factors of production. In general, if in the short run, a firm can cover its variable costs with its revenue, it chooses to operate.
(3)
A firm will shut-down in short run if its AVC > Price, and will exit the market if in long run, ATC > Price.
(a) If total cost > revenue at all output levels, in the long run firm will be making loses and will exit the market. But it is not known if in the short run, AVC is lower or higher than prices. So short-run firm behavior cannot be predicted.
(b) If TVC > revenue at all levels, the firm will definitely shut down in short run and exit the industry in the long run as well since it cannot charge a price that covers its variable costs of operation.
(4)
Initially all firms are in long run equilibrium, so none is making an excess profit.
When consumer income decreases, market demand decreases and prices fall. At lower prices, some firms will not be able to adjust their long run average cost downwards to equate the new, lower price, thereofre making long run losses. They will exit the market. As some firms exit, output supplied also decreases, which will increase prices. This process will continue until all remaining firms are in long run equilibrium, and market demand is equal to market supply, which will occur at a possibly higher price.
NOTE: Out of 10 questions, the first 4 are answered.
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