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Chapter 14-17 - Hbchh

Hbchh
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Accounting (ACC 156)

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Chapter 14: SOLUTIONS TO TEXT PROBLEMS:

Quick Quizzes

  1. When a competitive firm doubles the amount it sells, the price remains the same, so its total revenue doubles.

  2. The price faced by a profit-maximizing firm is equal to its marginal cost because if price were above marginal cost, the firm could increase profits by increasing output, while if price were below marginal cost, the firm could increase profits by decreasing output.

A profit-maximizing firm decides to shut down in the short run when price is less than average variable cost. In the long run, a firm will exit a market when price is less than average total cost.

  1. In the long run, with free entry and exit, the price in the market is equal to both a firm’s marginal cost and its average total cost, as Figure 1 shows. The firm chooses its quantity so that marginal cost equals price; doing so ensures that the firm is maximizing its profit. In the long run, entry into and exit from the industry drive the price of the good to the minimum point on the average-total-cost curve.

Figure 1

Questions for Review

  1. A competitive firm is a firm in a market in which: (1) there are many buyers and many sellers in the market; (2) the goods offered by the various sellers are largely the same; and (3) usually firms can freely enter or exit the market.

  2. Figure 2 shows the cost curves for a typical firm. For a given price (such as P*), the level

of output that maximizes profit is the output where marginal cost equals price (Q*), as long as price is greater than average variable cost at that point (in the short run), or greater than average total cost (in the long run).

Figure 2

  1. A firm will shut down temporarily if the revenue it would get from producing is less than the variable costs of production. This occurs if price is less than average variable cost.

  2. A firm will exit a market if the revenue it would get if it stayed in business is less than its total cost. This occurs if price is less than average total cost.

  3. A firm's price equals marginal cost in both the short run and the long run. In both the short run and the long run, price equals marginal revenue. The firm should increase output as long as marginal revenue exceeds marginal cost, and reduce output if marginal revenue is less than marginal cost. Profits are maximized when marginal revenue equals marginal cost.

  4. The firm's price equals the minimum of average total cost only in the long run. In the short run, price may be greater than average total cost, in which case the firm is making profits, or price may be less than average total cost, in which case the firm is making losses. But the situation is different in the long run. If firms are making profits, other firms will enter the industry, which will lower the price of the good. If firms are making losses, they will exit the industry, which will raise the price of the good. Entry or exit continues until firms are making neither profits nor losses. At that point, price equals average total cost.

  5. Market supply curves are typically more elastic in the long run than in the short run. In a competitive market, since entry or exit occurs until price equals the minimum of average total cost, the supply curve is perfectly elastic in the long run.

6 27 8 48 8 21

7 37 10 56 8 19

a. The firm should produce 5 or 6 units to maximize profit.

b. Marginal revenue and marginal cost are graphed in Figure 3. The curves cross at a quantity between 5 and 6 units, yielding the same answer as in part (a).

c. This industry is competitive since marginal revenue is the same for each quantity. The industry is not in long-run equilibrium, since profit is positive.

Figure 3

  1. a. Figure 4 shows the short-run effect of declining demand for beef. The shift of the industry demand curve from D 1 to D 2 reduces the quantity from Q 1 to Q 2 and reduces the price from P 1 to P 2. This affects the firm, reducing its quantity from q 1 to q 2. Before the decline in the price, the firm was making zero profits; afterwards, profits are negative, as average total cost exceeds price.

Figure 4

b. Figure 5 shows the long-run effect of declining demand for beef. Since firms were losing money in the short run, some firms leave the industry. This shifts the supply curve from S 1 to S 3. The shift of the supply curve is just enough to increase the price back to its original level, P 1. As a result, industry output falls still further, to Q 3. For firms that remain in the industry, the rise in the price to P 1 returns them to their original situation, producing quantity q 1 and earning zero profits.

Figure 5

  1. Figure 6 shows that although high prices cause an industry to expand, entry into the industry eventually returns prices to the point of minimum average total cost. In the figure, the industry is originally in long-run equilibrium. The industry produces output Q 1 , where supply curve S 1 intersects demand curve D 1 , and the price is P 1. At this point

Figure 7

  1. The rise in the price of petroleum increases production costs for individual firms and thus shifts the industry supply curve up, as shown in Figure 8. The typical firm's initial marginal-cost curve is MC 1 and its average-total-cost curve is ATC 1. In the initial equilibrium, the industry supply curve, S 1 , intersects the demand curve at price P 1 , which is equal to the minimum average total cost of the typical firm. Thus the typical firm earns no economic profit.

The increase in the price of oil shifts the typical firm's cost curves up to MC 2 and ATC 2 , and shifts the industry supply curve up to S 2. The equilibrium price rises from P 1 to P 2 , but the price does not increase by as much as the increase in marginal cost for the firm. As a result, price is less than average total cost for the firm, so profits are negative.

In the long run, the negative profits lead some firms to exit the industry. As they do so, the industry-supply curve shifts to the left. This continues until the price rises to equal the minimum point on the firm's average-total-cost curve. The long-run equilibrium occurs with supply curve S 3 , equilibrium price P 3 , industry output Q 3 , and firm's output q 3. Thus, in the long run, profits are zero again and there are fewer firms in the industry.

Figure 8

  1. a. Figure 9 illustrates the situation in the U. textile industry. With no international trade, the market is in long-run equilibrium. Supply intersects demand at quantity Q 1 and price $30, with a typical firm producing output q 1.

Figure 9

b. The effect of imports at $25 is that the market supply curve follows the old supply curve up to a price of $25, then becomes horizontal at that price. As a result, demand exceeds domestic supply, so the country imports textiles from other countries. The typical domestic firm now reduces its output from q 1 to q 2 , incurring losses, since the large fixed costs imply that average total cost will be much higher than the price.

c. In the long run, domestic firms will be unable to compete with foreign firms because their costs are too high. All the domestic firms will exit the industry and

exceeds average total cost, the representative firm now earns positive profits.

c. Since gold mines are earning positive economic profits, over time other firms will enter the industry. This will shift the supply curve to the right, reducing the price below P 2. But it's unlikely that the price will fall all the way back to P 1 , since gold is in short supply. Costs for new firms are likely to be higher than for older firms, since they'll have to discover new gold sources. So it's likely that the long- run supply curve in the gold industry is upward sloping. That means the long-run equilibrium price will be higher than it was initially.

Figure 11

  1. a. Figure 12 shows cost curves for a California refiner and a non-California refiner. Since the California refiner has access to lower-cost oil, its costs are lower.

Figure 12

b. In long-run equilibrium, the price is determined by the costs of non-California refiners, since California refiners cannot supply the entire market. The market

price will equal the minimum average total cost of the other refiners; they will thus earn zero profits. Since California refiners have lower costs, they will earn positive profits, equal to (P* - ATCC) x QC.

c. Yes, there is a subsidy to California refiners that is not passed on to consumers. The subsidy accounts for the long-run profits of the California refiners. It arises simply because the oil cannot be exported.

Chapter 15: SOLUTIONS TO TEXT PROBLEMS:

Quick Quizzes

  1. A market might have a monopoly because: (1) a key resource is owned by a single firm; (2) the government gives a single firm the exclusive right to produce some good; and (3) the costs of production make a single producer more efficient than a large number of producers.

Examples of monopolies include: (1) the water producer in a small town, which owns a key resource, the one well in town; (2) pharmaceutical companies who are given a patent on a new drug by the government; and (3) a bridge, which is a natural monopoly because (if the bridge is uncongested) having just one bridge is efficient. Many other examples are possible.

  1. A monopolist chooses the amount of output to produce by finding the quantity at which marginal revenue equals marginal cost. It finds the price to charge by finding the point on the demand curve at that quantity.

  2. A monopolist produces a quantity of output that’s less than the quantity of output that maximizes total surplus because it produces the quantity at which marginal cost equals marginal revenue rather than the quantity at which marginal cost equals price.

  3. Policymakers can respond to the inefficiencies caused by monopolies in one of four ways: (1) by trying to make monopolized industries more competitive; (2) by regulating the behavior of the monopolies; (3) by turning some private monopolies into public enterprises; and (4) by doing nothing at all. Antitrust laws prohibit mergers of large companies and prevent them from coordinating their activities in ways that make markets less competitive, but such laws may keep companies from merging to gain from synergies. Some monopolies, especially natural monopolies, are regulated by the government, but it is hard to keep a monopoly in business, achieve marginal-cost pricing, and give the monopolist incentive to reduce costs. Private monopolies can be taken over by the government, but the companies are not likely to be well run. Sometimes doing nothing at all may seem to be the best solution, but there are clearly deadweight losses from monopoly that society will have to bear.

  4. Examples of price discrimination include: (1) movie tickets, for which children and

  5. Figure 1 shows the demand, marginal-revenue, and marginal-cost curves for a monopolist. The intersection of the marginal-revenue and marginal-cost curves determines the profit-maximizing level of output, Qm. The demand curve then shows the profit-maximizing price, Pm.

Figure 1

  1. The level of output that maximizes total surplus in Figure 1 is where the demand curve intersects the marginal-cost curve, Qc. The deadweight loss from monopoly is the triangular area between Qc and Qm that is above the marginal-cost curve and below the demand curve. It represents deadweight loss, since society loses total surplus because of monopoly, equal to the value of the good (measured by the height of the demand curve) less the cost of production (given by the height of the marginal-cost curve), for the quantities between Qm and Qc.

  2. The government has the power to regulate mergers between firms because of antitrust laws. Firms might want to merge to increase operating efficiency and reduce costs, something that is good for society, or to gain monopoly power, which is bad for society.

  3. When regulators tell a natural monopoly that it must set price equal to marginal cost, two problems arise. The first is that, because a natural monopoly has a constant marginal cost that is less than average cost, setting price equal to marginal cost means that the price is less than average cost, so the firm will lose money. The firm would then exit the industry unless the government subsidized it. However, getting revenue for such a subsidy would cause the government to raise other taxes, increasing the deadweight loss. The second problem of using costs to set price is that it gives the monopoly no incentive to reduce costs.

  4. One example of price discrimination is in publishing books. Publishers charge a much higher price for hardback books than for paperback books—far higher than the difference in production costs. Publishers do this because die-hard fans will pay more for a

hardback book when the book is first released. Those who don't value the book as highly will wait for the paperback version to come out. The publisher makes greater profit this way than if it charged just one price.

A second example is the pricing of movie tickets. Theaters give discounts to children and senior citizens because they have a lower willingness to pay for a ticket. Charging different prices helps the theater increase its profit above what it would be if it charged just one price.

Problems and Applications

  1. The following table shows revenue, costs, and profits, where quantities are in thousands, and total revenue, total cost, and profit are in millions of dollars:

Price Quantity (1,000s)

Total Revenue

Margina l Revenue

Total Cost

Profit

$ 100 0 $ 0 ---- $ 2 $ -

90 100 9 $ 9 3 6

80 200 16 7 4 12

70 300 21 5 5 16

60 400 24 3 6 18

50 500 25 1 7 18

40 600 24 -1 8 16

30 700 21 -3 9 12

20 800 16 -5 10 6

10 900 9 -7 11 -

0 1,000 0 -9 12 -

a. A profit-maximizing publisher would choose a quantity of 400,000 at a price of $60 or a quantity of 500,000 at a price of $50; both combinations would lead to profits of $18 million.

b. Marginal revenue is always less than price. Price falls when quantity rises because the demand curve slopes downward, but marginal revenue falls even more than price because the firm loses revenue on all the units of the good sold when it lowers the price.

c. Figure 2 shows the marginal-revenue, marginal-cost, and demand curves. The marginal-revenue and marginal-cost curves cross between quantities of 400, and 500,000. This signifies that the firm maximizes profits in that region.

Figure 3

  1. Figure 3 illustrates a natural monopolist setting price, PATC, equal to average total cost. The equilibrium quantity is QATC. Marginal cost pricing would yield the price PMC and quantity QMC. For quantities between QATC and QMC, the benefit to consumers (measured by the demand curve) exceeds the cost of production (measured by the marginal cost curve). This means that the deadweight loss from setting price equal to average total cost is the triangular area shown in the figure.

  2. Mail delivery has an always-declining average-total-cost curve, since there are large fixed costs for equipment. The marginal cost of delivering a letter is very small. However, the costs are higher in isolated rural areas than they are in densely populated urban areas, since transportation costs differ. Over time, increased automation has reduced marginal cost and increased fixed costs, so the average-total-cost curve has become steeper at small quantities and flatter at high quantities.

  3. If the price of tap water rises, the demand for bottled water increases. This is shown in Figure 4 as a shift to the right in the demand curve from D 1 to D 2. The corresponding marginal-revenue curves are MR 1 and MR 2. The profit-maximizing level of output is where marginal cost equals marginal revenue. Prior to the increase in the price of tap water, the profit-maximizing level of output is Q 1 ; after the price increase, it rises to Q 2. The profit-maximizing price is shown on the demand curve: it is P 1 before the price of tap water rises, and it rises to P 2 after. Average cost is AC 1 before the price of tap water rises and AC 2 after. Profit increases from (P 1 - AC 1 ) x Q 1 to (P 2 - AC 2 ) x Q 2.

Figure 4

  1. a. Figure 5 illustrates the market for groceries when there are many competing supermarkets with constant marginal cost. Output is QC, price is PC, consumer surplus is area A, producer surplus is zero, and total surplus is area A.

Figure 5

b. If the supermarkets merge, Figure 6 illustrates the new situation. Quantity declines from QC to QM and price rises to PM. Area A in Figure 5 is equal to area B + C + D + E + F in Figure 6. Consumer surplus is now area B + C, producer surplus is area D + E, and total surplus is area B + C + D + E. Consumers transfer the amount of area D + E to producers and the deadweight loss is area F.

of how severe the monopoly problem was.

  1. a. The table below shows total revenue and marginal revenue for the bridge. The profit-maximizing price would be where revenue is maximized, which will occur where marginal revenue equals zero, since marginal cost equals zero. This occurs at a price of $4 and quantity of 400. The efficient level of output is 800, since that's where price equals marginal cost equals zero. The profit-maximizing quantity is lower than the efficient quantity because the firm is a monopolist.

Price Quantity Total Revenue Marginal Revenue $ 8 0 $ 0 ---- 7 100 700 $ 7 6 200 1,200 5 5 300 1,500 3 4 400 1,600 1 3 500 1,500 - 2 600 1,200 - 1 700 700 - 0 800 0 -

b. The company should not build the bridge because its profits are negative. The most revenue it can earn is $1,600,000 and the cost is $2,000,000, so it would lose $400,000.

Figure 7

c. If the government were to build the bridge, it should set price equal to marginal

cost to be efficient. But marginal cost is zero, so the government should not charge people to use the bridge.

d. Yes, the government should build the bridge, because it would increase society's total surplus. As shown in Figure 7, total surplus has area 1/2 x 8 x 800,000 = $3,200,000, which exceeds the cost of building the bridge.

  1. a. Figure 8 illustrates the drug company's situation. They will produce quantity Q 1 at price P 1. Profits are equal to (P 1 - AC 1 ) x Q 1.

Figure 8

b. The tax on the drug increases both marginal cost and average cost by the amount of the tax. As a result, as shown in Figure 9, quantity is reduced to Q 2 , price rises to P 2 , and average cost plus tax rises to AC 2.

Figure 9

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Chapter 14-17 - Hbchh

Course: Accounting (ACC 156)

180 Documents
Students shared 180 documents in this course

University: University of Iloilo - PHINMA

Was this document helpful?
Chapter 14/Firms in Competitive Markets 263
Chapter 14: SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. When a competitive firm doubles the amount it sells, the price remains the same, so its
total revenue doubles.
2. The price faced by a profit-maximizing firm is equal to its marginal cost because if price
were above marginal cost, the firm could increase profits by increasing output, while if
price were below marginal cost, the firm could increase profits by decreasing output.
A profit-maximizing firm decides to shut down in the short run when price is less than
average variable cost. In the long run, a firm will exit a market when price is less than
average total cost.
3. In the long run, with free entry and exit, the price in the market is equal to both a firm’s
marginal cost and its average total cost, as Figure 1 shows. The firm chooses its quantity
so that marginal cost equals price; doing so ensures that the firm is maximizing its profit.
In the long run, entry into and exit from the industry drive the price of the good to the
minimum point on the average-total-cost curve.
Figure 1
Questions for Review
1. A competitive firm is a firm in a market in which: (1) there are many buyers and many
sellers in the market; (2) the goods offered by the various sellers are largely the same; and
(3) usually firms can freely enter or exit the market.
2. Figure 2 shows the cost curves for a typical firm. For a given price (such as P*), the level

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