Managerial Economics, 7e, Global Edition (Keat)

Chapter 8 Pricing and Output Decisions: Perfect Competition and Monopoly (Appendices
8A and 8B)

Multiple-Choice Questions

(1) Which of the following markets comes closes to the model of perfect competition?
A) automobile industry
B) information technology industry
C) aerospace industry
D) agriculture

(2) A feature of perfect competition is

A) use of non-price competition by firms.
B) mutual interdependence among firms.
C) unique products.
D) standardized products.

(3) Which is a required characteristic of a perfectly competitive industry?

A) There are few firms so that none can influence market price.
B) Products are highly differentiated.
C) Barriers to entry are high.
D) None of the above

(4) Which of the following characteristics is most important in differentiating between perfect
competition and all other types of markets?
A) whether or not the product is standardized
B) whether or not there is complete market information about price
C) whether or not firms are price takers
D) All of the above are equally important.

(5) Demand facing an individual, perfectly competitive firm is

A) perfectly inelastic at the quantity the firm chooses to produce.
B) perfectly inelastic at the quantity determined by market forces.
C) perfectly elastic at the price the firm chooses to charge.
D) perfectly elastic at the price determined by market forces.

(6) In perfect competition

A) the firm's demand curve is relatively elastic.
B) the firm's demand curve is relatively inelastic.
C) the firm's demand curve is perfectly elastic.
D) the firm's demand curve is perfectly inelastic.

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(7) For a demand curve that is horizontal, the marginal revenue curve
A) will be to the right of the demand curve and half as steep.
B) will be to the left of the demand curve and half as steep.
C) will be to the right of the demand curve and twice as steep.
D) will be the same as the demand curve.

(8) According to the shutdown rule, a firm should produce no output in the short run if
A) price is below minimum average total cost.
B) price is above minimum average total cost.
C) total revenues are lower than total fixed costs.
D) price is below minimum average variable costs.

(9) Which of the following conditions would definitely cause a perfectly competitive company to
shut down in the short run?
A) P < MC
B) P = MC < AC
C) P < AVC
D) P = MR

(10) A normal profit is

A) revenues minus opportunity cost of zero.
B) revenues minus accounting cost of zero.
C) a zero accounting profit.
D) revenues minus accounting and opportunity cost of zero.

(11) In economic analysis, any amount of profit earned above zero is considered "above normal"
because
A) normally firms are supposed to earn zero profit.
B) this would indicate that the firm's revenue exceeded both its accounting and opportunity cost.
C) this would indicate that the firm was at least earning a profit equal to its opportunity cost.
D) this would indicate that the firm's revenue exceeded its accounting cost.

(12) If a perfectly competitive firm incurs an economic loss, it should

A) shut down immediately.
B) try to raise its price.
C) shut down in the long run.
D) shut down if this loss exceeds fixed cost.

(13) A perfectly competitive firm sells 15 units of output at the going market price of $10.
Suppose its average fixed cost is $15 and its average variable cost is $8. Its contribution margin
(i.e., contribution to fixed cost) is
A) $30.
B) $150.
C) $105.
D) Cannot be determined from the above information

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(14) Mars Inc. produces 100,000 boxes of Snickers bars which sell for $4 a box. If variable costs
are $3 per box, and it has $150,000 fixed operating costs, in the short run, it should
A) shut down as fixed costs are not being covered.
B) keep producing as profits are $50,000.
C) keep producing as variable costs are being met.
D) keep producing as total costs are being recovered.

(15) In perfect competition, if firms enter the market in the long run
A) total supply will increase causing market price to increase.
B) total supply will decrease causing market price to decrease.
C) total supply will decrease causing market price to increase.
D) total supply will increase causing market price to decrease.

(16) In long-run equilibrium a perfectly competitive firm will operate where the price is
A) greater than MR but equal to MC and minimum ATC.
B) greater than MR and MC, but equal to minimum ATC.
C) greater than MC and minimum ATC, but equal to MR.
D) equal to MR, MC and minimum to ATC.

(17) The principle marginal revenue equal-marginal-cost rule for maximizing profit
A) does not apply to firms in the monopoly or oligopolistic industries.
B) applies only for firm in perfect competition but not in monopolistic competition.
C) applies to new firms but not to existing firms in an industry.
D) applies to all the firms in all industries.

(18) Assume a profit maximizing firm's short-run cost is TC = 700 + 60Q. If its demand curve is
P = 300 - 15Q, what should it do in the short run?
A) shut down
B) continue operating in the short run even though it is losing money
C) continue operating because it is earning an economic profit
D) Cannot be determined from the above information

(19) Assume a perfectly competitive firm's short-run cost is TC = 100 + 160Q + 3Q2. If the
market price is $196, what should it do?
A) produce 5 units and continue operating
B) produce 6 units and continue operating
C) produce zero units (i.e., shut down)
D) Cannot be determined from the above information

(20) Which of the following is false?

A) A monopolist will sell less at a higher price.
B) A monopolist has a marginal revenue that is less than the price.
C) A monopolist will produce where MR = MC.
D) A monopolist is a price taker.

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(21) A monopolist sells 100 units at $10 per unit and 90 units at $15 per unit. The marginal
revenue from the tenth unit is
A) $1000.
B) $1350.
C) $100.
D) $350.

(22) For a linear demand curve that is downward sloping, the marginal revenue curve
A) will be to the left of the demand curve and twice as steep.
B) will be to the right of the demand curve and twice as steep.
C) will be to the left of the demand curve and half as steep.
D) will be the same as the demand curve.

(23) If an industry could be organized either perfectly competitively or as monopoly, a monopoly

would
A) produce less output.
B) produce where P > MC.
C) charge higher prices.
D) All of the above

(24) Which of the following correctly completes this statement? The monopolist's marginal
revenue
A) will be greater than price.
B) will be less than price.
C) will be equal to price.
D) will be greater than total revenues.

(25) At the point at which P=MC, suppose that a perfectly competitive firm's MC = $100, its
AVC = $80 and its AC = $110. This firm should
A) shut down immediately.
B) continue operating in the short run.
C) try to take advantage of economies of scale.
D) try to increase its advertising and promotion.

(26) When a firm produces at the point where MR = MC, the profit that it is earning is
considered to be
A) maximum.
B) normal.
C) above normal.
D) Not enough information is provided.

(27) When a firm has the power to establish its price

A) P = MR.
B) P = MC.
C) P > MR.
D) P < MR.

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(28) When MR = MC
A) marginal profit is maximized.
B) total profit is maximized.
C) marginal profit is positive.
D) total profit is zero.

(29) In the short run, which of the following would indicate that a perfectly competitive firm is
producing an output for which it is receiving a normal profit?
A) P > AC
B) AVC < P < AC
C) P = AC
D) P = AVC

(30) A firm that seeks to maximize its revenue is most likely to adhere to which of the
following?
A) MR = MC
B) MR = 0
C) MR = P
D) MR < MC

(31) Which of the following is true for a monopoly?

A) P = MC
B) P = MR
C) P > MR
D) P < MR

(32) Which of the following is true about a monopoly?

A) Its demand curve is generally less elastic than in more competitive markets.
B) It will always earn economic profit.
C) It will always produce the same as a perfectly competitive firm.
D) It will always be subject to government regulation.
E) None of the above is true.

(33) A monopoly will usually produce

A) where its demand curve is inelastic.
B) where its demand curve is elastic.
C) where its demand curve is either elastic or inelastic.
D) only when its demand curve is perfectly inelastic.

(34) The main difference between the price-quantity graph of a perfectly competitive firm and a
monopoly is
A) that the competitive firm's demand curve is horizontal, while that of the monopoly is
downward sloping.
B) that a monopoly always earns an economic profit while a competitive company always earns
only normal profit.
C) that a monopoly maximizes its profit when marginal revenue is greater than marginal cost.
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D) that a monopoly does not incur increasing marginal cost.

(35) When the slope of the total revenue curve is equal to the slope of the total cost curve
A) profit is maximized.
B) marginal revenue equals marginal cost.
C) the marginal cost curve intersects the total average cost curve.
D) the total cost curve is at its minimum.
E) Both A and B

(36) Monopoly is characterized by

A) unique products.
B) market entry and exit are difficult or impossible.
C) non-price competition not necessary.
D) All of the above

(37) The fact that a perfectly competitive firm has a perfectly elastic demand curve means
A) there is no limit to the firm's profits.
B) there is no limit to the firm's revenues.
C) that it can sell all it wants at any price.
D) None of the above

(38) In the short run a firm should shut down if it cannot

A) make normal profits.
B) make economic profits.
C) cover its variable costs.
D) cover its fixed costs.

(39) Firms are "price makers" if they

A) have sufficient market power to set their product price.
B) make the market price their product price.
C) make their product price competitive.
D) None of the above

(40) If a monopoly wants to maximize its profit, it should produce in the range where
A) its average costs are declining.
B) its demand curve is elastic.
C) its marginal costs are declining.
D) its marginal costs are less than its average costs.

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Analytical Questions

(1) A perfectly competitive firm has total revenue and total cost curves given by:

TR = 100Q
TC = 5,000 + 2Q + 0.2 Q2

a. Find the profit-maximizing output for this firm.

b. What profit does the firm make?

Ans-
a. Profit = TR – TC
Profit = 100Q – 5000 -2Q – 0.2Q2
d(Profit) / dQ = 100 – 0 – 2 – 0.4Q = 0
Q = 245 units

b. Profit = 100(245) – 5000 – 2(245) – 0.2(245)2

Profit = $31,015

(2) What does it mean to say that a perfectly competitive firm is a price taker? Can't a firm set
any price it chooses?
Ans- It means that the firm is not in a position to dictate the price, the market sets the price of the
product and the firm takes that price.

(3) Why would a firm choose to remain in an industry in which it makes an economic profit of
zero?
Ans- Because even though the economic profit might be zero, the accounting profit might not
necessarily be zero, which means that the firm might be covering it’s variable and fixed costs by
the revenue.

4) You've been hired by an unprofitable firm to determine whether it should shut down its
operation. The firm currently uses 70 workers to produce 300 units of output per day. The daily
wage (per worker) is $100, and the price of the firm's output is $30. The cost of other variable
inputs is $500 per day. Although you don't know the firm's fixed cost, you know that it is high
enough that the firm's total costs exceed its total revenue. You know that the marginal cost of the
last unit is $30. Should the firm continue to operate at a loss? Carefully explain your answer.
Ans- Yes the firm should continue to operate because even though the fixed costs are high, the
variable cost($7500) is easily covered by the total revenue($9000).

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(5) Suppose that a perfectly competitive industry is in long-run equilibrium, and demand
increases. Explain the short- and long-run effects on the firm and the industry.
Ans-
If demand increases, the price will increase, which will signal firms to produce more. Existing
firms will make positive profits. Thus, in the long run, firms will enter until price returns to the
original price. Therefore, demand changes in an industry like this will cause price changes in the
short run only.

(6) Market price is $50. The firm's marginal cost curve is given by MC = 10 + 2Q.

a. Find the profit-maximizing output for the firm.

b. At this output, is the firm making a profit? Explain your answer.
Ans-
a. P = MR = $50
MR = MC
50 = 10 + 2Q
Q = 20 units
b. TR = 50 X 20 = $1000
TC = 10Q + Q2 (using integration)
TC = 10(20) + (20)2 = 600
TR – TC = 1000 – 600 = $400
Yes, the firm is making a profit
Another way to answer this question is that since part (a) already has found the volume
at which profit is maximized, hence the firm is in fact making a profit.

(7) A monopolist has demand and cost curves given by:

QD = 1000 - 2P
TC = 5,000 + 50Q

a. Find the monopolist's profit-maximizing quantity and price.

b. Find the monopolist's profit.
Ans-
a. P = 500 -Q/2
TR = PQ
TR = 500Q – Q2 /2

MR = dTR/dQ
MR = 500 – Q

MC = dTC/dQ
MC = 50

MR = MC
500 – Q = 50
Q = 450 units

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P = 500 – (450)/2 = $275

b. Profit = TR – TC
Profit = 500(450) – (450)2/2 – 5000 – 50(450) = $99,250.

(8) A monopolist has demand and cost curves given by:

QD = 10,000 - 20P
TC = 1,000 + 10Q + .05Q2

a. Find the monopolist's profit-maximizing quantity and price.

b. Find the monopolist's profit.
Ans-
a. P = 500 – Q/20
TR = 500Q – Q2/20

MR = dTR/dQ
MR = 500 -Q/10

MC =dTC/dQ
MC= 10 + 0.1Q

MR=MC
500 – Q/10 = 10 + 0.1Q
Q =2450

P = 500 – 2450/20
P = $377.5

b. Profit = TR – TC
Profit = 500(2450) – (2450)2/20 – 1000 – 10(2450) - 0.05(2450)2
Profit = $599,250

(9) True, false, or uncertain? Any firm that is not covering fixed costs should shut down in the
short run.
Ans- False

(10) A perfectly competitive firm has the cost function TC = 1000 + 2Q + 0.1 Q2. What is the
lowest price at which this firm can break even?
Ans- TR = TC
PQ = 1000 +2Q + 0.1Q2
P = 1000/Q + 2 + 0.1Q

(11) Describe the difference in market structure between monopoly and oligopoly.
Ans- In monopoly, there is just one firm that is providing the goods/services. Whereas, in

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oligopoly there is a small number of relatively large firms serving the market.

(12) Explain the difference between economic and normal profits.

Ans- If the accounting profit is equal to the opportunity cost of the business, then it is referred to
as Normal Profit. If the accounting profit exceeds the out of pocket cost and the opportunity
cost, then it is referred to as Economic Profit

(13) Describe the process by which the competitive market establishes a price at which all firms
are just earning normal profits.
Ans- Over a long period of time, prices that enable firms to earn above-normal profit would
induce other firms to enter the market, and prices below the normal level would cause firms to
leave the market. This causes price to rise toward the level in which the remaining firms would
earn a normal profit.

(14) A monopolist's demand function is P = 1624 - 4Q, and its total cost function is

TC = 22,000 + 24Q -4Q2 + 1/3 Q3, where Q is output produced and sold.

a. At what level of output and sales (Q) and price (P) will total profits be maximized?
b. At what level of output and sales (Q) and price (P) will total revenue be maximized?
c. At what price (P) should the monopolist shut down?
Ans-
a. TR = 1624Q – 4Q2
MR= dTR/dQ
MR = 1624 -8Q

MC = dTC/dQ
MC= 0 + 24 -8Q + Q2

MR=MC
1624-8Q = 24-8Q+Q2
Q2 = 1600
Q = 40 units

P =1624 -4(40)
P = $1464
b. Can not understand
c. The monopolist should shut down when the even the variable costs are not being met by
the revenue generated by the price set.

(15) What are the limitations in using break-even analysis?

Ans-
1. It assumes the existence of linear relationships, constant prices, and constant average variable
costs. However, when the effects of relatively small changes in quantity are measured, linear
revenues and variable costs are certainly good approximations of reality.
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2. It is assumed costs (and expenses) are either variable or fixed. The existence of fixed costs
limits this analysis to the short run. Changes in capacity are ordinarily not considered.
3. For break-even analysis to be used, only a single product must be produced in a plant or, if
there are several products, their mix must remain constant.
4. The analysis does not result in identification of an optimal point; it focuses on evaluating the
effect of changes in quantity on cost and profits

(16) What is the Degree of Operating Leverage?

Ans- A coefficient that measures the effect a percentage change in quantity has on the
percentage change in profit

(17) How can break-even analysis be used to project the level of operation needed to achieve a
targeted profit level?
Ans- The following minor adjustment to the formula for breakeven can provide the output
requirement for a specific required profit.

Q = (TFC + Profit requirement)/(P – AVC)

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