Chapter 8 Managerial Economics Paul Keat Solution PDF

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Managerial Economics, 7e, Global Edition (Keat) Chapter 8 Pricing and Output Decisions: Perfect Competition and Monopoly (Appendices 8A and 8B)Multiple-Choice Questions Which of the following markets comes closes to the model of perfect competition? A) automobile industry B) information technology i...

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Managerial Economics, 7e, Global Edition (Keat) Chapter 8 Pricing and Output Decisions: Perfect Competition and Monopoly (Appendices 8A and 8B) Multiple-Choice Questions 1) Which of the following markets comes closes to the model of perfect competition? A) automobile industry B) information technology industry C) aerospace industry D) agriculture Answer: D Diff: 1 2) A feature of perfect competition is A) use of non-price competition by firms. B) mutual interdependence among firms. C) unique products. D) standardized products. Answer: D Diff: 1 3) Which is a required characteristic of a perfectly competitive industry? A) There are few firms so that none can influence market price. B) Products are highly differentiated. C) Barriers to entry are high. D) None of the above Answer: D Diff: 1 4) Which of the following characteristics is most important in differentiating between perfect competition and all other types of markets? A) whether or not the product is standardized B) whether or not there is complete market information about price C) whether or not firms are price takers D) All of the above are equally important. Answer: C Diff: 2 5) Demand facing an individual, perfectly competitive firm is A) perfectly inelastic at the quantity the firm chooses to produce. B) perfectly inelastic at the quantity determined by market forces. C) perfectly elastic at the price the firm chooses to charge. D) perfectly elastic at the price determined by market forces. Answer: D Diff: 2 1

6) In perfect competition A) the firm's demand curve is relatively elastic. B) the firm's demand curve is relatively inelastic. C) the firm's demand curve is perfectly elastic. D) the firm's demand curve is perfectly inelastic. Answer: C Diff: 2 7) For a demand curve that is horizontal, the marginal revenue curve A) will be to the right of the demand curve and half as steep. B) will be to the left of the demand curve and half as steep. C) will be to the right of the demand curve and twice as steep. D) will be the same as the demand curve. Answer: D Diff: 3 8) According to the shutdown rule, a firm should produce no output in the short run if A) price is below minimum average total cost. B) price is above minimum average total cost. C) total revenues are lower than total fixed costs. D) price is below minimum average variable costs. Answer: D Diff: 3 9) Which of the following conditions would definitely cause a perfectly competitive company to shut down in the short run? A) P < MC B) P = MC < AC C) P < AVC D) P = MR Answer: C Diff: 2 10) A normal profit is A) revenues minus opportunity cost of zero. B) revenues minus accounting cost of zero. C) a zero accounting profit. D) revenues minus accounting and opportunity cost of zero. Answer: D Diff: 1

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11) In economic analysis, any amount of profit earned above zero is considered "above normal" because A) normally firms are supposed to earn zero profit. B) this would indicate that the firm's revenue exceeded both its accounting and opportunity cost. C) this would indicate that the firm was at least earning a profit equal to its opportunity cost. D) this would indicate that the firm's revenue exceeded its accounting cost. Answer: B Diff: 2 12) If a perfectly competitive firm incurs an economic loss, it should A) shut down immediately. B) try to raise its price. C) shut down in the long run. D) shut down if this loss exceeds fixed cost. Answer: D Diff: 2 13) A perfectly competitive firm sells 15 units of output at the going market price of $10. Suppose its average fixed cost is $15 and its average variable cost is $8. Its contribution margin (i.e., contribution to fixed cost) is A) $30. B) $150. C) $105. D) Cannot be determined from the above information Answer: A Diff: 3 14) Mars Inc. produces 100,000 boxes of Snickers bars which sell for $4 a box. If variable costs are $3 per box, and it has $150,000 fixed operating costs, in the short run, it should A) shut down as fixed costs are not being covered. B) keep producing as profits are $50,000. C) keep producing as variable costs are being met. D) keep producing as total costs are being recovered. Answer: C Diff: 3 15) In perfect competition, if firms enter the market in the long run A) total supply will increase causing market price to increase. B) total supply will decrease causing market price to decrease. C) total supply will decrease causing market price to increase. D) total supply will increase causing market price to decrease. Answer: D Diff: 2

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16) In long-run equilibrium a perfectly competitive firm will operate where the price is A) greater than MR but equal to MC and minimum ATC. B) greater than MR and MC, but equal to minimum ATC. C) greater than MC and minimum ATC, but equal to MR. D) equal to MR, MC and minimum to ATC. Answer: D Diff: 3 17) The principle marginal revenue equal-marginal-cost rule for maximizing profit A) does not apply to firms in the monopoly or oligopolistic industries. B) applies only for firm in perfect competition but not in monopolistic competition. C) applies to new firms but not to existing firms in an industry. D) applies to all the firms in all industries. Answer: D Diff: 3 18) Assume a profit maximizing firm's short-run cost is TC = 700 + 60Q. If its demand curve is P = 300 - 15Q, what should it do in the short run? A) shut down B) continue operating in the short run even though it is losing money C) continue operating because it is earning an economic profit D) Cannot be determined from the above information Answer: C Diff: 3 19) Assume a perfectly competitive firm's short-run cost is TC = 100 + 160Q + 3Q2. If the market price is $196, what should it do? A) produce 5 units and continue operating B) produce 6 units and continue operating C) produce zero units (i.e., shut down) D) Cannot be determined from the above information Answer: B Diff: 3 20) Which of the following is false? A) A monopolist will sell less at a higher price. B) A monopolist has a marginal revenue that is less than the price. C) A monopolist will produce where MR = MC. D) A monopolist is a price taker. Answer: D Diff: 3

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21) A monopolist sells 100 units at $10 per unit and 90 units at $15 per unit. The marginal revenue from the tenth unit is A) $1000. B) $1350. C) $100. D) $350. Answer: D Diff: 2 22) For a linear demand curve that is downward sloping, the marginal revenue curve A) will be to the left of the demand curve and twice as steep. B) will be to the right of the demand curve and twice as steep. C) will be to the left of the demand curve and half as steep. D) will be the same as the demand curve. Answer: B Diff: 2 23) If an industry could be organized either perfectly competitively or as monopoly, a monopoly would A) produce less output. B) produce where P > MC. C) charge higher prices. D) All of the above Answer: D Diff: 2 24) Which of the following correctly completes this statement? The monopolist's marginal revenue A) will be greater than price. B) will be less than price. C) will be equal to price. D) will be greater than total revenues. Answer: B Diff: 1 25) At the point at which P=MC, suppose that a perfectly competitive firm's MC = $100, its AVC = $80 and its AC = $110. This firm should A) shut down immediately. B) continue operating in the short run. C) try to take advantage of economies of scale. D) try to increase its advertising and promotion. Answer: B Diff: 3

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26) When a firm produces at the point where MR = MC, the profit that it is earning is considered to be A) maximum. B) normal. C) above normal. D) Not enough information is provided. Answer: D Diff: 3 27) When a firm has the power to establish its price A) P = MR. B) P = MC. C) P > MR. D) P < MR. Answer: C Diff: 3 28) When MR = MC A) marginal profit is maximized. B) total profit is maximized. C) marginal profit is positive. D) total profit is zero. Answer: B Diff: 2 29) In the short run, which of the following would indicate that a perfectly competitive firm is producing an output for which it is receiving a normal profit? A) P > AC B) AVC < P < AC C) P = AC D) P = AVC Answer: C Diff: 2 30) A firm that seeks to maximize its revenue is most likely to adhere to which of the following? A) MR = MC B) MR = 0 C) MR = P D) MR < MC Answer: B Diff: 2

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31) Which of the following is true for a monopoly? A) P = MC B) P = MR C) P > MR D) P < MR Answer: C Diff: 2 32) Which of the following is true about a monopoly? A) Its demand curve is generally less elastic than in more competitive markets. B) It will always earn economic profit. C) It will always produce the same as a perfectly competitive firm. D) It will always be subject to government regulation. E) None of the above is true. Answer: A Diff: 3 33) A monopoly will usually produce A) where its demand curve is inelastic. B) where its demand curve is elastic. C) where its demand curve is either elastic or inelastic. D) only when its demand curve is perfectly inelastic. Answer: B Diff: 2 34) The main difference between the price-quantity graph of a perfectly competitive firm and a monopoly is A) that the competitive firm's demand curve is horizontal, while that of the monopoly is downward sloping. B) that a monopoly always earns an economic profit while a competitive company always earns only normal profit. C) that a monopoly maximizes its profit when marginal revenue is greater than marginal cost. D) that a monopoly does not incur increasing marginal cost. Answer: A Diff: 2 35) When the slope of the total revenue curve is equal to the slope of the total cost curve A) profit is maximized. B) marginal revenue equals marginal cost. C) the marginal cost curve intersects the total average cost curve. D) the total cost curve is at its minimum. E) Both A and B Answer: E Diff: 3

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36) Monopoly is characterized by A) unique products. B) market entry and exit are difficult or impossible. C) non-price competition not necessary. D) All of the above Answer: D Diff: 1 37) The fact that a perfectly competitive firm has a perfectly elastic demand curve means A) there is no limit to the firm's profits. B) there is no limit to the firm's revenues. C) that it can sell all it wants at any price. D) None of the above Answer: B Diff: 2 38) In the short run a firm should shut down if it cannot A) make normal profits. B) make economic profits. C) cover its variable costs. D) cover its fixed costs. Answer: C Diff: 2 39) Firms are "price makers" if they A) have sufficient market power to set their product price. B) make the market price their product price. C) make their product price competitive. D) None of the above Answer: A Diff: 2 40) If a monopoly wants to maximize its profit, it should produce in the range where A) its average costs are declining. B) its demand curve is elastic. C) its marginal costs are declining. D) its marginal costs are less than its average costs. Answer: B Diff: 2

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Analytical Questions 1) A perfectly competitive firm has total revenue and total cost curves given by: TR = 100Q TC = 5,000 + 2Q + 0.2 Q2 a. Find the profit-maximizing output for this firm. b. What profit does the firm make? Answer: a. MR = 100 MC = 2 + .4Q 100 = 2 + .4Q Q* = 245 b. Profit = 100 ∗ 245 - 5,000 - 2(245) - 0.2 (245)2 = $7,005 2) What does it mean to say that a perfectly competitive firm is a price taker? Can't a firm set any price it chooses? Answer: A firm can set any price it chooses, but in a perfectly competitive industry, it will do no good to choose anything but the market price. At a higher price, no one will buy (since products are assumed to be identical) and at a lower price, you lose revenue without gaining sales, since you can presumably sell all you want to at the market price. Thus the firm is said to be a price taker. 3) Why would a firm choose to remain in an industry in which it makes an economic profit of zero? Answer: Making an economic profit of zero does not mean that the firm is not making any money. It means that it is covering all its costs, including opportunity costs. This means that all resources employed are earning just as much as they would in their next-best use, and thus that there is no gain from moving them to their next -best use. 4) You've been hired by an unprofitable firm to determine whether it should shut down its operation. The firm currently uses 70 workers to produce 300 units of output per day. The daily wage (per worker) is $100, and the price of the firm's output is $30. The cost of other variable inputs is $500 per day. Although you don't know the firm's fixed cost, you know that it is high enough that the firm's total costs exceed its total revenue. You know that the marginal cost of the last unit is $30. Should the firm continue to operate at a loss? Carefully explain your answer. Answer: VC = $7,000 + 500. Thus AVC = 7500/300 = $25. Since P > AVC, the firm should continue to operate in the short run.

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5) Suppose that a perfectly competitive industry is in long-run equilibrium, and demand increases. Explain the short- and long-run effects on the firm and the industry. Answer: Short run: An increase in demand raises equilibrium price and quantity. Existing firms produce more (because the higher price means that MR=MC at a higher quantity) and earn positive economic profits. Long run: Positive profits attract new firms into the industry. The increase in supply reduces price and further increases quantity. Firms continue to enter until economic profits return to zero, and there is no further incentive for entry. 6) Market price is $50. The firm's marginal cost curve is given by MC = 10 + 2Q. a. Find the profit-maximizing output for the firm. b. At this output, is the firm making a profit? Explain your answer. Answer: a. 50 = 10 + 2Q Q* = 20 b. It is impossible to say without further information. We know that at a quantity of 20, the firm will maximize profit or minimize loss, but without information on total costs, we cannot tell if there is a profit or loss. 7) A monopolist has demand and cost curves given by: QD = 1000 - 2P TC = 5,000 + 50Q a. Find the monopolist's profit-maximizing quantity and price. b. Find the monopolist's profit. Answer: a. MR = 500 - Q MC = 50 50 = 500 - Q Q* = 450 P* = $275 b. Profit = 275 ∗ 450 - 5,000 - 50 ∗ 450 = $96,250

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8) A monopolist has demand and cost curves given by: QD = 10,000 - 20P TC = 1,000 + 10Q + .05Q2 a. Find the monopolist's profit-maximizing quantity and price. b. Find the monopolist's profit. Answer: a. MR = 500 - 0.1 Q MC = 10 + 0.1Q 10 + 0.1Q = 500 - 0.1 Q Q* = 2,450 P* = $377.50 b. Profit = (377.50) ∗ 2450 - 1,000 - 10 ∗ 2450 - 0.05(2450)2 = $599,250 9) True, false, or uncertain? Any firm that is not covering fixed costs should shut down in the short run. Answer: False. Fixed costs are sunk and should have no effect on short-run decisions. If a firm is not covering variable costs, it should shut down, because those costs are avoidable. 10) A perfectly competitive firm has the cost function TC = 1000 + 2Q + 0.1 Q2. What is the lowest price at which this firm can break even? Answer: MC = 2 + 0.2Q AC = (1000/Q) + 2 + 0.1Q Set MC = AC. for minimum AC, or 2 + 0.2Q = (1000/Q) + 2 + 0.1Q, or Q = 100, and at that point, AC = $22. This is the lowest price at which the firm can break even. 11) Describe the difference in market structure between monopoly and oligopoly. Answer: Monopoly has only one producer because the product is unique, or has no close substitutes, or government gives it the exclusive authority to produce and sell that product. Oligopoly has relatively few large firms producing standardized or differentiated products, but for which entry into or exit from the industry is very difficult, so that they are mutually interdependent in their pricing-output decisions. 12) Explain the difference between economic and normal profits. Answer: Normal profit is the amount of profit necessary to insure that a firm continues to operate in the long run, and it is based on the profit that could be earned in its next best alternative activity. It is equal to the sum of its accounting cost and opportunity cost. Economic profit is the amount of profit above normal profit: profit in excess of what could be earned in its next best alternative activity.

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13) Describe the process by which the competitive market establishes a price at which all firms are just earning normal profits. Answer: Above normal profits will entice new firms to enter the industry, thereby driving down market price and firm profits until they reach the normal level, after which no additional firms enter the industry. Below normal profits will cause some firms to exit the industry, thereby raising market price and firm profits until the normal level is reestablished, and no further firms exit the industry. 14) A monopolist's demand function is P = 1624 - 4Q, and its total cost function is TC = 22,000 + 24Q -4Q2 + 1/3 Q3, where Q is output produced and sold. a. At what level of output and sales (Q) and price (P) will total profits be maximized? b. At what level of output and sales (Q) and price (P) will total revenue be maximized? c. At what price (P) should the monopolist shut down? Answer: a. Total Profits are maximized where MR = MC, and MR = dTR/dQ, with TR = P(Q), and MC = dTC/dQ. TR = 1624Q -4Q2, so MR = 1624 - 8Q. MC = 24 - 8Q + Q2. MR = MC is 1624 - 8Q = 24 - 8Q + Q2, or 1600 = Q2, and Q = 40. With Q = 40, P = 1464. b. Total Revenue is maximized when MR = 0, or 1624 - 8Q = 0, or Q = 203 with P = 203. c. Shut down would occur whenever price(P) is less than average variable cost (AVC), or below P = AVC, or 1624 - 4Q = 24 - 4Q + 1/3 Q2, or 1600 =1/3 Q2, or Q2 = 4800, or Q = 69 (approximately). When Q = 69, P = 1348, so any price below 1348 would cause the firm to shut down since it is not covering its variable costs. 15) What are the limitations in using break-even analysis? Answer: It requires the use of linear cost and revenue functions; it isn't applicable if the functions are non-linear. It assumes that there are fixed costs, which means the analysis can be applied only to short-run operations. It can't handle multiple product situations, unless the product mixes are constant. It can't be used to determine profit-maximizing levels of operations. 16) What is the Degree of Operating Leverage? Answer: It is an elasticity formula which calculates the percentage change in profit resulting from some percentage change in the level of operation (output and sales). 17) How can break-even analysis be used to project the level of operation needed to achieve a targeted profit level? Answer: The targeted level of profit can be factored into the break-even equation as a fixed cost, and then determine the level of output and sales at which the operating costs plus fixed costs plus desired profit would just equal sales revenue: Q = (TFC + Desired Profit)/(P - AVC), where Q = output, TFC = total fixed cost, P = sales price, and AVC = average variable cost.

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