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LOS b: Determine the profit maximizing (loss minimizing) output for a perfectly competitive firm, and explain marginal cost, marginal revenue, and economic profit and loss.

When a firm operates under conditions of perfect competition, marginal revenue always equals:

When a firm operates under conditions of perfect competition, marginal revenue always equals price. This is because, in perfect competition, price is constant (a horizontal line) so that marginal revenue is constant.

Suppose a price-taker firm produces baseball bats that sell at a price of $100 each. This firm’s average total cost at the current level of production is $150 per bat, and the average fixed cost is $40 per bat. Which of the following statements is most accurate regarding this firm? They should:

A)	continue producing baseball bats because they are covering their fixed costs.

B)	shut down in the short run because their average variable cost is greater than their price.

C)	shut down in the short run because their average total cost is greater than their price.

Variable costs = $150 (ATC) ? $40 (AFC) = $110 (AVC). At a selling price of $100 the firm is not covering its variable costs and will have losses greater than its fixed costs if it stays in business.

A perfectly competitive firm will not expand its output beyond the quantity where:

A)	the marginal cost is greater than marginal revenue.

B)	the market price is equal to its marginal cost.

C)	its marginal revenue is positive.

A perfectly competitive firm will tend to expand its output so long as the market price is greater than marginal cost. In the short term and long term, profit is maximized when P = MC.

Which of the following is most accurate for a price-taker firm in long-run equilibrium when there are no barriers to entry?

For a price-taker firm, long-run equilibrium is where P = MC = ATC. For price taking firms, P = MC. Competition eliminates economic profits in the long run so that P = ATC.

Under perfect competition, a firm will experience zero long term economic profit when:

A)	MC is less than ATC.

B)	MC = ATC = MR = price.

C)	price is less than average total cost.

Under perfect competition, a firm will experience zero long term profits when P = MC = MR = ATC. It recovers all costs including opportunity costs and earns zero economic profit.

A)	produce quantity where P = MR = MC.

B)	be a revenue maximizer.

C)	face an inelastic demand curve.

A firm operating as a price taker will produce quantity where MC = MR. It will maximize profit and not revenue. In the long run, it will make zero economic profits after taking into account fair return on capital.

A)	produce a quantity where marginal revenue is less than marginal cost.

B)	face a vertical demand curve.

C)	generate zero economic profit.

A firm operating under conditions of perfect competition will generate zero economic profit in the long run. Firms may generate economic profits in the short run, but due to the lack of entry barriers, new competitors will enter the market and prices will adjust downward until economic profits become zero.

A firm operating under perfect competition will experience economic losses when which of the following conditions exists?

A)	Marginal cost is less than average total cost.

B)	Marginal revenue is greater than average total cost.

C)	Market price is less than average total cost.

Under perfect competition, a firm will experience economic losses when its selling price is less than average total cost.

Assume that a perfectly competitive firm produces 10 units of a good and sells them each for a price (P) equal to $15. If the marginal cost (MC) of the 10th unit is $15 and the average total cost (ATC) is $13, economic profit for the firm is closest to:

When MR = MC = P, economic profit equals TR – TC. In this case, TR = $150 = 10 × $15 and TC = $130 = 10 × ATC = 10 × $13. So, economic profit is $20 = $150 ? $130.

A)	greater than average fixed cost.

B)	greater than marginal cost.

C)	less than marginal cost.

A purely competitive firm will tend to expand its output so long as the market price (marginal revenue) is greater than marginal cost. In the short term and long term, profit is maximized when P = MC.

A)	its marginal revenue is greater than the market price.

B)	the market price is greater than the marginal cost.

C)	its marginal revenue is positive.

A competitive firm faces a flat demand curve. This means the price is constant and the marginal revenue line is flat. A firm will continue to produce as long as MR > MC, so the competitive firm will produce as long as P > MC. It will stop when MC = MR = P.

A)	revenue is greater than the average cost.

B)	cost is less than average cost.

C)	revenue is greater than marginal cost.

All firms will continue to expand production until marginal revenue = marginal cost.

A)	keep running as long as it is covering its variable costs.

B)	raise prices.

C)	produce more.

In the short run, if the firm is covering its average variable costs and some of its fixed costs it will continue to operate as long as the situation is temporary.

If the price is below ATC then the firm is losing money. If the firm believes the price will never exceed ATC the only way to eliminate fixed costs is to go out of business.

A)	small economic profits.

B)	zero economic profits.

C)	large economic profits.

Zero economic profits means the firm is earning a normal rate of return and a positive accounting profit. Since perfectly competitive firms have no barriers to entry, economic profits cannot be positive in the long run because new competitors will enter the market place driving down economic profits to zero.

Under perfect competition, a firm will be inclined to increase output as long as which of the following conditions exists?

A)	Marginal revenue is greater than marginal cost.

B)	Marginal revenue is greater than the average cost.

C)	Marginal cost is less than average cost.

A firm will continue to expand output as long as it is possible to earn an economic profit. In other words, a firm will expand output as long as marginal revenue is greater than marginal cost.

A perfectly competitive firm will continue to increase output so long as which of the following conditions exists?

A)	Marginal revenue is positive.

B)	Marginal revenue is greater than price.

C)	Market price is greater than marginal cost.

A perfectly competitive firm will tend to expand its output so long as the market price is greater than marginal cost since price and marginal revenue are equal. In the short term and long term, profit is maximized when marginal cost and marginal revenue are equal (i.e., MC = MR).

A firm in a perfectly competitive industry that seeks to maximize profit is most likely to continue production in the short run as long which of the following conditions exists? Price is equal to or greater than:

If a firm is covering its average variable costs, it will continue to operate in the short run since it is covering some portion of its fixed costs.

Which of the following most accurately describes the relationship between price (P), marginal cost (MC), and marginal revenue (MR) at the profit maximizing output level for a firm in a perfectly competitive industry?

For a perfectly competitive firm, maximum profit occurs at the output level where marginal revenue equals marginal cost. And, since the demand curve faced by each firm in perfect competition is horizontal, marginal revenue is equal to price.