Economics 101
Fall 2003
Answers to Practice Questions #9

1) The goal of a competitive firm is to maximize profit. At which point does the firm choose to produce?
  a. When total revenue is maximized
  b. When total cost is minimized
  c. When marginal revenue is zero
  d. When marginal cost is zero
  e. When marginal cost is equal to marginal revenue

e. The profit is maximized when marginal cost is equal to marginal revenue.

2) The competitive firm’s supply curve is the same as its _____________. 
  a. marginal revenue curve
  b. marginal cost curve above the shutdown point
  c. average total cost curve
  d. average variable cost curve
  e. average fixed cost curve

b. The competitive firm’s supply curve is the same as its marginal cost curve above the shutdown point. 

* Use the table below showing one firm’s quantity, total revenue and total cost to answer question 3 through 6. 
Quantity	Total Revenue	Total Cost	
0	0	5	
1	10	11	
2	20	18	
3	30	26	
4	40	35	
5	50	45	
6	60	56	
7	70	68	
8	80	81	

3) From the total revenue curve, we know that the industry where the firm operates is a _____________.
  a. competitive market
  b. monopoly market
  c. oligopoly market
  d. monopolistic competitive market
  e. we cannot determine what kind of industry this is from the above data.

a. Since the marginal revenue is constant, we can say the market is competitive. 

4) The technology exhibits ________ returns to scale. 

The marginal cost is increasing, so the technology exhibits decreasing returns to scale. 

5) Draw the supply curve of this firm. What is the optimal quantity for this firm? What is the resulting profit?

The supply curve is marginal cost curve; MC=Q+5. The optimal quantity for this firm is Q=5, where the marginal cost equals to the marginal revenue. The profit is TR-TC=5. 

6) In the long run, what can we expect in this industry?
 a. Firms will exit.
 b. Firms will enter the industry.
 c. There will be no entry or exit in this industry.
 d. Only one firm will operate.
 e. None of the above.

b. Since there’s positive profit, there will be more entry to this industry. 

7) Suppose there are 20 firms in the industry. The market demand curve is Q=-10P+200. The marginal cost curve of each firm is MC=2q. What is the long run equilibrium quantity and price in the market?

From the marginal cost curve, one firm’s supply curve is q=P/2. So, the market supply curve is Q=20*P/2=10P. Then, the long run equilibrium quantity is 100, and the price is 10. 

* Use the following graph of one firm’s cost functions to answer questions 8 and 9. 
quantity

cost

MC

ATC

10

5

8) The market demand curve is 50P+Q=1000. How many firms will be in this market in the long run? 

In the long run, the firms make zero profit. So the price should be 10 and quantity produced is 5. Then, the quantity demanded in the market is Q=1000-50*10=500. So, there will be 500/5=100 firms in this market.  

9) In above question, the market demand changes due to the population expansion. Now, the demand curve is 50P+Q=1200. How many additional firms will enter in the long run? (Assume this is a constant cost industry.) Draw the long run supply curve for this market.

In short run, the 100 firms enjoy the positive profit. However, again, in the long run, the firms make zero profit with the entry of more firms. So, the price is 10 and quantity produce by one firm is 5, too. Then, the quantity demanded in the market is Q=1200-50*10=700. Thus, there will be 700/5=140 firms. Therefore, 40 firms enters in this market. 
In the long run with free entry and exit, the market supply curve is horizontal.

P

Q

Long-run Supply

10

10) Which is NOT true for monopoly?
 a. The monopolist has much greater power than any single firm in a competitive market. 
 b. The fundamental cause of monopoly is barriers to entry.
 c. Monopoly can arise due to the decreasing returns to scale. 
 d. The government can create monopolies.
 e. Natural monopoly is a monopoly that arises because a single firm can supply a good or service to an entire market at a smaller cost than could two or more firms. 

c. A natural monopoly can arises when there are economies of scale over the relevant range of output. 

* Answer the following questions about monopoly.
11) Suppose the demand curve for a monopolist is Q=11-P. Fill in the table below.

Quantity	Price	Revenue	Marginal revenue	
1	10	10	10	
2	9	18	8	
3	8	24	6	
4	7	28	4	
5	6	30	2	
6	5	30	0	
7	4	28	-2	
8	3	24	-4	
9	2	18	-6	
10	1	10	-8	

12) Calculate the profit of monopoly and deadweight loss in the following graph.

P

Q

MC

D

MR

10

6

15

 20

ATC

4

profit

DWL

The profit maximization quantity is 15. So, the profit is 15*(10-4)=$90. The deadweight loss is ½*(20-15)*(10-6)=$10. This is the inefficiency of monopoly. 

13) Suppose the demand curve for a monopolist is Q=12-P and the marginal cost for the monopolist is MC=Q. What is the profit maximizing quantity and price for the monopoly?

If Q=4, then MR=MC. So the profit maximization quantity is 4 and the price is P=11-4=7 from demand curve.