Practice Questions
The Theory of the Firm under under Perfect Competition
Recall the formula for a firm's total revenue in a perfectly competitive market.
If a firm's total revenue from selling 20 units is Rs 400 in a perfectly competitive market, calculate the average revenue.
Contrast normal profit and super-normal profit in the context of a firm's total costs.
A competitive firm sells 50 units of output at a market price of Rs 8 per unit. Calculate the firm's marginal revenue from selling the 51st unit.
Define the term perfect competition as a market structure.
Critique the statement: 'A perfectly competitive firm will shut down production in the long run if the market price falls below its minimum average total cost.'
Critique the assumption of 'perfect information' in the model of perfect competition.
Justify why the market supply curve is derived from the horizontal summation of individual firms' supply curves.
Define the term price elasticity of supply.
Analyze how the imposition of a per-unit tax of Rs 2 on a good affects a perfectly competitive firm's short-run supply curve. Explain the relationship between the old and new supply curves.
Propose a reason why a perfectly competitive firm might continue to produce in the short run even while it is incurring an economic loss. Justify your proposal.
Justify why the short-run supply curve of a firm is the rising part of its short-run marginal cost curve at and above the minimum average variable cost.
Formulate an argument explaining why the feature of 'free entry and exit' is essential for ensuring that firms in a perfectly competitive market earn only normal profit in the long run.
List the three conditions that must hold for a firm to maximize its profit at a positive output level in the short run.
Explain why the total revenue curve of a firm under perfect competition is an upward-sloping straight line that passes through the origin.
A firm's short-run marginal cost (SMC) is Rs 15, its average variable cost (AVC) is Rs 12, and its average total cost (ATC) is Rs 18. If the market price is Rs 15, apply the conditions of profit maximization to determine if the firm should produce in the short run.
Compare and contrast the short-run shut-down point and the long-run exit point for a firm in a perfectly competitive market. Use the relationship between price and relevant cost curves in your explanation.
Using a hypothetical numerical example with two firms, demonstrate how the market supply schedule is derived. Assume Firm 1 supplies 0 units at Rs 5 and 2 units at Rs 10. Assume Firm 2 supplies 0 units at Rs 5, but starts supplying at Rs 8, providing 1 unit, and supplies 3 units at Rs 10.
Examine how a technological innovation that lowers production costs for all firms in a competitive market affects the market supply curve.
A firm in a perfectly competitive market observes that at its current output level, the market price is Rs 20, its marginal cost is Rs 18, and its marginal cost curve is rising. Analyze what this firm should do to maximize its profit.
A firm in a perfectly competitive market sells 100 units of a good at a market price of Rs 20 per unit. When the price rises to Rs 25, it sells 150 units. Calculate the price elasticity of supply for this firm.
Create a numerical example to demonstrate a situation where a firm's supply is elastic. Formulate a justification for why the supply of this particular good might be elastic.
Design a graphical representation of a perfectly competitive firm earning super-normal profits in the short run. Justify the key components of your diagram.
Propose how the price elasticity of supply for a manufactured good would differ from that of an agricultural good like fresh strawberries. Justify your proposal.
Evaluate the claim that 'For a price-taking firm, average revenue is always equal to marginal revenue.' Justify whether this holds true for a firm that is not a price-taker, such as a monopoly.
Name the point on the supply curve at which a firm earns only normal profit.
Identify the effect of a unit tax imposed by the government on a firm's supply curve.
Describe how technological progress affects a firm's marginal cost curve and, consequently, its supply curve.
Explain what a firm's short-run supply curve represents and identify the cost curves used to derive it.
Describe how the market supply curve is derived from the supply curves of individual firms.
Examine the effect of an increase in the wages paid to labor, a key input, on a firm's short-run supply curve. Explain the direction of the shift.
Justify the condition that for a profit-maximizing firm, the marginal cost must be non-decreasing at the equilibrium output level where price equals marginal cost.
Analyze why a profit-maximizing firm in a perfectly competitive market will not choose to produce at an output level where the marginal cost curve is downward sloping, even if the price is equal to the marginal cost at that point.
Propose a strategy for a firm that discovers its profit-maximizing output level (where P = MC) is at a point where the price is below its long-run average cost but above its short-run average variable cost. Justify your proposed actions for both the short run and the long run.
In a market with two firms, the supply function for Firm A is S_A = 2p - 8 (for p ≥ 4) and for Firm B is S_B = p - 5 (for p ≥ 5). Solve for the market supply function (S_M).
Create a hypothetical scenario for a small wheat farm facing a sudden government-imposed per-unit tax. Formulate the farm's immediate response in the short run, justifying its decision based on cost curves.
Summarize the reasoning behind the shutdown condition for a profit-maximizing firm in the short run. Explain why a firm will produce zero output if the market price is below the minimum average variable cost.
Explain the difference between a firm's short-run shutdown point and its long-run exit point.
Evaluate the 'price-taking' assumption in a perfectly competitive market. Justify why it is considered a critical feature and critique its applicability in most real-world markets.
Describe the four defining features of a perfectly competitive market and explain how they lead to price-taking behavior.
Evaluate the long-term consequences for a perfectly competitive market if a significant technological innovation is adopted by all firms. Formulate how this affects price, output, and firm profitability.
Analyze the situation of a firm in the long run where the market price is below its long-run average cost (LRAC) but above its long-run marginal cost (LRMC). Examine the profit-maximizing decision for this firm in the long run.
A candle maker operates in a perfectly competitive market where the price is Rs 10 per box. The firm's marginal cost of producing the 8th box is Rs 8, for the 9th box it is Rs 10, and for the 10th box it is Rs 13. Apply the profit maximization rule to find the optimal number of boxes the firm should produce.
Explain why a profit-maximizing firm will not produce at an output level where the marginal cost curve is downward sloping, even if price equals marginal cost at that point.