Perfect Competition
1. What is the difference between economic profit and producer surplus? (1 point)
Economic profit is the difference between total revenue and total cost. Producer surplus is the
difference between total revenue and total variable cost or total revenue and marginal cost. Thus, the
difference between profit and PS is the fixed cost of production.
2. Suppose a given industry is characterized by perfect competition, so each firm is earning zero
economic profit. If the product price falls, no firms can survive. Do you agree or disagree with this
statement? Explain your answer. (1 point)
Disagree with this statement because as the price falls, an adjustment will take place. If price falls
below average total cost, then in the short run firms will continue to produce. In the long-run, however,
some firms will cease production. In general, enough firms survive such that profit will again be zero.
3. At its current level of production a profit-maximizing firm in a competitive market receives $15 for
each unit it produces, and faces an average cost of $10. At the market price of $15, the firm’s
marginal cost curve crosses the marginal revenue curve at an output level of 1000 units. Draw a
diagram that depicts the typical firm in this market. What is the firm’s current profit? What is likely
to occur in this market and why? (2 points)
Current profit = (p – ac)q = (15 – 10)1000 = $5000. Given that the firm is earning economic profit, we
would expect to see entry until economic profit is zero.
4. If each firm in the shoe industry is operating where p = LRMC, does it follow that the industry is in
long-run equilibrium? Explain your answer (1 point)
Not necessarily. In the long-run, the firm has to be operating at the efficient scale, where P = LRMC =
LRAC.
5. Assume the market for wheat is perfectly competitive. The market price is $12 per bushel, the
firms face fixed costs of $1000, and variable costs of $300 per worker per week. Fill in the Table
below. What is the profit maximizing level of output? (2 points)
L Q TC MC TR MR Profit
0 0
1000 - 0 - -1000
1 50
1300 6.00 600 12 -700
2 110
1600 5.00 1320 12 -280
3 180
1900 4.29 2160 12 260
4 240
2200 5.00 2880 12 680
5 290
2500 6.00 3480 12 980
6 315
2800 12.00 3780 12 980
7 335
3100 15.00 4020 12 920
8 350
3400 20.00 4200 12 800
The profit maximizing level of output is where MR =MC, which is at 315 bushels of wheat per week.
docsity.com
