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Solution
Solution
Perfect Competition and
the Supply Curve
1. For each of the following, is the business a price-taking producer? Explain your
answers.
a. A cappuccino café in a university town where there are dozens of very similar cap-
puccino cafés
b. The makers of Pepsi-Cola
c. One of many sellers of zucchini at a local farmers’ market
1. a. The cappuccino café is probably a price-taking producer, especially if there are a
large number of cafés in town, since each will have a small market share and each
produces a standardized product.
b. There is only one manufacturer of Pepsi-Cola, and it works hard to differentiate
its product from others in the minds of consumers. It is not a price-taking pro-
ducer.
c. Zucchini sellers at the farmers’ market are price-taking producers; there are many
of them, none of whom can affect the market price for zucchini, which is a stan-
dardized product.
2. For each of the following, is the industry perfectly competitive? Referring to mar-
ket share, standardization of the product, and/or free entry and exit, explain your
answers.
a. Aspirin
b. Alicia Keys concerts
c. SUVs
2. a. Yes, aspirin is produced in a perfectly competitive industry. Many manufacturers
produce aspirin, the product is standardized, and new manufacturers can easily
enter and existing manufacturers can easily exit the industry.
b. No, Alicia Keys concerts are not produced in a perfectly competitive industry.
There is not free entry into the industry—there is only one Alicia Keys.
c. No, SUVs are not produced in a perfectly competitive industry. There are only a
few manufacturers of SUVs, each holding a large market share, and SUVs are not a
standardized product in the minds of consumers.
S-
chapter:
Solution
3. Kate’s Katering provides catered meals, and the catered meals industry is perfectly
competitive. Kate’s machinery costs $100 per day and is the only fixed input. Her
variable cost consists of the wages paid to the cooks and the food ingredients. The
variable cost per day associated with each level of output is given in the accompany-
ing table.
a. Calculate the total cost, the average variable cost, the average total cost, and the
marginal cost for each quantity of output.
b. What is the break-even price? What is the shut-down price?
c. Suppose that the price at which Kate can sell catered meals is $21 per meal. In
the short run, will Kate earn a profit? In the short run, should she produce or
shut down?
d. Suppose that the price at which Kate can sell catered meals is $17 per meal. In
the short run, will Kate earn a profit? In the short run, should she produce or
shut down?
e. Suppose that the price at which Kate can sell catered meals is $13 per meal. In
the short run, will Kate earn a profit? In the short run, should she produce or
shut down?
3. a. From Kate’s variable cost ( VC ), the accompanying table calculates Kate’s total cost
( TC ), average variable cost ( AVC ), average total cost ( ATC ), and marginal cost
( MC ).
b. Kate’s break-even price, the minimum average total cost, is $19.33, at an output
quantity of 30 meals. Kate’s shut-down price, the minimum average variable cost,
is $15, at an output of 20 meals.
c. When the price is $21, Kate will make a profit: the price is above her break-even
price. And since the price is above her shut-down price, Kate should produce in
the short run, not shut down.
d. When the price is $17, Kate will incur a loss: the price is below her break-even
price. But since the price is above her shut-down price, Kate should produce in the
short run, not shut down.
Quantity of meals VC
0 $
10 200
20 300
30 480
40 700
50 1,
Quantity MC AVC ATC of meals VC TC of meal of meal of meal
0 $0.00 $100.00 — — $20. 10 200.00 300.00 $20.00 $30.
20 300.00 400.00 15.00 20.
30 480.00 580.00 16.00 19.
40 700.00 800.00 17.50 20.
50 1,000.00 1,100.00 20.00 22.
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Solution
b. When the price is $25, Bob will sell 8,000 DVDs per month and make a profit
of $78,000. If there is free entry into the industry, this profit will attract new
firms. As firms enter, the price of DVDs will eventually fall until it is equal to the
minimum average total cost. Here, the average total cost reaches its minimum of
$13.83 at 6,000 DVDs per month. So the long-run price of DVDs will be $13.83.
5. Consider Bob’s DVD company described in Problem 4. Assume that DVD production
is a perfectly competitive industry. For each of the following questions, explain your
answers.
a. What is Bob’s break-even price? What is his shut-down price?
b. Suppose the price of a DVD is $2. What should Bob do in the short run?
c. Suppose the price of a DVD is $7. What is the profit-maximizing quantity of
DVDs that Bob should produce? What will his total profit be? Will he produce or
shut down in the short run? Will he stay in the industry or exit in the long run?
d. Suppose instead that the price of DVDs is $20. Now what is the profit-
maximizing quantity of DVDs that Bob should produce? What will his total
profit be now? Will he produce or shut down in the short run? Will he stay in
the industry or exit in the long run?
5. a. Bob’s break-even price is $13.83 because this is the minimum average total cost.
His shut-down price is $3, the minimum average variable cost, because below that
price his revenue does not even cover his variable cost.
b. If the price of DVDs is $2, the price is below Bob’s shut-down price of $3. So Bob
should shut down in the short run.
c. If DVDs sell for $7, Bob should produce 5,000 DVDs because for any greater
quantity his marginal cost exceeds his marginal revenue (the market price). His
total profit will be −$35,000, a loss of $35,000. In the short run, he will produce
because his short-run loss if he were to shut down would be greater; it would
equal his fixed costs of $50,000. In the long run, he will exit the industry because
his profit is negative: the price of $7 per DVD is below his break-even price of
d. If DVDs sell instead for $20, Bob should produce 7,000 DVDs because at this
quantity his marginal cost approximately equals his marginal revenue (the market
price). His total profit will be $41,000. In the short run, he will produce because
he is covering his variable cost (the price is above the shut-down price). In the
long run, he will stay in the industry because his profit is not negative (the price
is above the break-even price).
6. Consider again Bob’s DVD company described in Problem 4.
a. Draw Bob’s marginal cost curve.
b. Over what range of prices will Bob produce no DVDs in the short run?
c. Draw Bob’s individual supply curve.
S-186 C H A P T E R 1 2 P E R F E C T C O M P E T I T I O N A N D T H E S U P P LY C U R V E
Solution
Solution6. a. Bob’s marginal cost curve is shown in the accompanying diagram.
MC
(^01 2 3 4 5 6 7 8 9 )
$
50
40
30
20
10
Cost of DVD
Quantity of DVDs (thousands)
b. Bob will produce no DVDs if the price falls below $3 because $3 is the lowest
point on the average variable cost curve—his shut-down price.
c. The individual supply curve is shown in the accompanying diagram. It is his MC
curve above the minimum average variable cost.
S
1
3 (^02 3 4 5 6 7 8 9 )
$
50
40
30
20
10
Price of DVD
Quantity of DVDs (thousands)
7. a. A profit-maximizing business incurs an economic loss of $10,000 per year. Its
fixed cost is $15,000 per year. Should it produce or shut down in the short run?
Should it stay in the industry or exit in the long run?
b. Suppose instead that this business has a fixed cost of $6,000 per year. Should it
produce or shut down in the short run? Should it stay in the industry or exit in
the long run?
7. a. In the short run, the business should produce. If it shuts down, the short-run
annual loss will be $15,000, its fixed cost; but if it produces, the loss will be only
$10,000. In the long run, the business should exit the industry because it is incur-
ring a loss.
b. In the short run, the business should shut down. If it shuts down, the short-
run loss will be $6,000, its fixed cost; if it continues to produce, the loss will be
$10,000. In the long run, the firm should exit the industry because it is incurring
a loss.
C H A P T E R 1 2 P E R F E C T C O M P E T I T I O N A N D T H E S U P P LY C U R V E S-
Solution9. a. This firm’s fixed cost is $5, since even when the firm produces no output, it
incurs a total cost of $5. The marginal cost ( MC ), average variable cost ( AVC ),
and average total cost ( ATC ) are given in the accompanying table.
b. This firm’s minimum average variable cost is $4 at 2 units of output. So the firm
will produce only if the price is greater than $4, making its individual supply curve
the same as its marginal cost curve above the shut-down price of $4. The same is
true for all other firms in the industry. That is, if the price is $4, the quantity sup-
plied by all 100 firms is 200. The quantity supplied by all 100 firms at a price of $
is 300, and so on. The accompanying diagram illustrates this principle.
(^0200 400 600 800) 1,000 1,200 1,4001,6001,8002,
$
10
8
6
4
Price
Quantity
S
D
E
c. The quantity supplied equals the quantity demanded at a price of $10—the (short-
run) market equilibrium price. So the quantity bought and sold in this market
is 500 units. Each firm will maximize profit by producing 5 units of output—the
greatest quantity at which price equals or exceeds marginal cost. At 5 units of out-
put, each firm’s revenue is $10 × 5 = $50. Its total cost is $34. So it makes a profit
of $16.
Quantity TC MC AVC ATC
0 $5.00 — — $5. 1 10.00 $5.00 $10.
2 13.00 4.00 6.
3 18.00 4.33 6.
4 25.00 5.00 6.
5 34.00 5.80 6.
6 45.00 6.67 7.
C H A P T E R 1 2 P E R F E C T C O M P E T I T I O N A N D T H E S U P P LY C U R V E S-
Solution
10. A new vaccine against a deadly disease has just been discovered. Presently, 55 people
die from the disease each year. The new vaccine will save lives, but it is not complete-
ly safe. Some recipients of the shots will die from adverse reactions. The projected
effects of the inoculation are given in the accompanying table:
a. What are the interpretations of “marginal benefit” and “marginal cost” here?
Calculate marginal benefit and marginal cost per each 10% increase in the rate of
inoculation. Write your answers in the table.
b. What proportion of the population should optimally be inoculated?
c. What is the interpretation of “profit” here? Calculate the profit for all levels of
inoculation.
10. a. The “marginal benefit” is the additional lives saved due to inoculation. The “mar-
ginal cost” is the additional deaths due to inoculation. The values are given in the
accompanying table.
Percent of Total deaths Total deaths Marginal population due to due to benefit of Marginal cost “Profit” of inoculated disease inoculation inoculation of inoculation inoculation
0 55 0 0 10 0 10 45 0 10 − 0 = 10 9 1 20 36 1 19 − 1 = 18 8 2 30 28 3 27 − 3 = 24 7 3 40 21 6 34 − 6 = 28 6 4 50 15 10 40 − 10 = 30 5 5 60 10 15 45 − 15 = 30 4 5 70 6 20 49 − 20 = 29 3 5 80 3 25 52 − 25 = 27 2 5 90 1 30 54 − 30 = 24 1 5 100 0 35 55 − 35 = 20
S-190 C H A P T E R 1 2 P E R F E C T C O M P E T I T I O N A N D T H E S U P P LY C U R V E
Total Marginal Percent Total deaths benefit Marginal of popu- deaths due to of cost of “Profit” lation due to inocu- inocu- inocu- of inocu- inoculated disease lation lation lation lation
(^0 55 0) __ __ __
(^10 45 0) __ __ __
(^20 36 1) __ __ __
(^30 28 3) __ __ __
(^40 21 6) __ __ __
(^50 15 10) __ __ __
(^60 10 15) __ __ __
(^70 6 20) __ __ __
(^80 3 25) __ __ __
(^90 1 30) __ __ __
100 0 35 __
d. Because unprofitable farms were operating in 1998, when prices were $2.65 per
bushel, we would expect that prior to 1998, prices were higher—assuming that
production costs were approximately the same. So prior to 1998, farms were at
least breaking even. Indeed, the average price of wheat was $4.25 per bushel in
1996 and $3.85 per bushel in 1995.
13. The accompanying table presents prices for washing and ironing a man’s shirt taken
from a survey of California dry cleaners.
a. What is the average price per shirt washed and ironed in Goleta? In Santa
Barbara?
b. Draw typical marginal cost and average total cost curves for California Cleaners in
Goleta, assuming it is a perfectly competitive firm but is making a profit on each
shirt in the short run. Mark the short-run equilibrium point and shade the area
that corresponds to the profit made by the dry cleaner.
c. Assume $2.25 is the short-run equilibrium price in Goleta. Draw a typical short-
run demand and supply curve for the market. Label the equilibrium point.
d. Observing profits in the Goleta area, another dry cleaning service, Diamond
Cleaners, enters the market. It charges $1.95 per shirt. What is the new average
price of washing and ironing a shirt in Goleta? Illustrate the effect of entry on the
average Goleta price by a shift of the short-run supply curve, the demand curve,
or both.
e. Assume that California Cleaners now charges the new average price and just
breaks even (that is, makes zero economic profit) at this price. Show the likely
effect of the entry on your diagram in part b.
f. If the dry cleaning industry is perfectly competitive, what does the average dif-
ference in price between Goleta and Santa Barbara imply about costs in the two
areas?
Dry Cleaner City Price
A-1 Cleaners Santa Barbara $1.
Regal Cleaners Santa Barbara 1.
St. Paul Cleaners Santa Barbara 1.
Zip Kleen Dry Cleaners Santa Barbara 1.
Effie the Tailor Santa Barbara 2.
Magnolia Too Goleta 2.
Master Cleaners Santa Barbara 2.
Santa Barbara Cleaners Goleta 2.
Sunny Cleaners Santa Barbara 2.
Casitas Cleaners Carpinteria 2.
Rockwell Cleaners Carpinteria 2.
Norvelle Bass Cleaners Santa Barbara 2.
Ablitt’s Fine Cleaners Santa Barbara 2.
California Cleaners Goleta 2.
Justo the Tailor Santa Barbara 2.
Pressed 4 Time Goleta 2.
King’s Cleaners Goleta 2.
S-192 C H A P T E R 1 2 P E R F E C T C O M P E T I T I O N A N D T H E S U P P LY C U R V E
Solution13. a. The average price per shirt washed and ironed is $2.25 in Goleta and $2.00 in
Santa Barbara.
b. The marginal cost curve ( MC ) cuts through the average total cost curve ( ATC ) at
the lowest point of the ATC curve. Since California Cleaners is making a profit,
price has to be above the break-even price (the minimum average total cost).
Given this, California Cleaners maximizes its profit by producing quantity Q 1 in
the accompanying diagram—the quantity at which its marginal cost equals the
market price.
E 1
MC
ATC
Profit
0 Q 1
Price
Quantity
$2.
c. The accompanying diagram shows the short-run market supply curve and the
market demand curve.
E MKT
S 1
D
0
Price
Quantity
$2.
Q 1^ MKT
d. The entry of a new firm increases the quantity supplied at each price and shifts
the supply curve to the right, as indicated by the move from S 1 to S 2 in the accom-
panying diagram. So the new equilibrium corresponds to a lower equilibrium
price, $2.20, and a higher equilibrium quantity.
S 1 S 2
D
0
Price
Quantity
$2.
E MKT
F MKT
Q 1^ MKT^ Q 2^ MKT
C H A P T E R 1 2 P E R F E C T C O M P E T I T I O N A N D T H E S U P P LY C U R V E S-
