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Problem Set 7
The following table shows the four topic sections of this chapter and the associated study guide problems that pertain to each topic section.
Section   Topic
 1        The Basics of Supply and Demand
             Problems M1-M6, S1-S2, L1-L2.
 2        Competitive Equilibrium
             Problems M7-M13, S3-S8, L3-L4.
 3        Market Efficiency
             Problems M14-M18, S9, L5-L7.
 4        International Trade
             Problems M19-M20, L8-L9.
Multiple Choice
M1       Demand is given by P = 1,000 – 10Q and supply by P = 400 + 20Q. Equilibrium price and output under perfect competition are
P = $600 and Q = 10 units.
P = $700 and Q = 30 units.
P = $800 and Q = 20 units.
P = $1,000 and Q = 30 units.
P = $800 and Q = 10 units.
M2       If for some reason the price of a good is below the equilibrium price, then
Finding inventories building up, suppliers will cut output, and raise prices.
Finding inventories depleted, suppliers will increase output and raise prices.
The demand curve shifts left until equilibrium is established at the existing price.
The supply curve shifts right until equilibrium is established at the existing price.
Consumers will bid up the good’s price, but there will be no increase in output.
M3       A favorable shift in the demand curve occurs when
a.         Suppliers place more goods on the market.
b.         The price of a good rises.
c.         Time passes. Next year’s demand will be very different than this year’s.
d.         The price of the good falls.
e.         Consumers want to buy more than before at a given price.
M4       A shift in the demand for sailboats due to an increase in income will typically cause
Higher prices of sailboats.
Lower prices of sailboats.
A shift in the supply curve for sailboats.
Lower output of sailboats.
No change in the price of sailboats.
M5       A shift in the supply curve of bicycles resulting from higher steel prices will lead to
Larger output of bicycles.
Lower prices of bicycles.
A shift in the demand curve for bicycles.
Lower output of bicycles.
No change in the price of bicycles.
M6       We observe that the price of food rises and the quantity purchased also rises. Thus the
Supply curve has shifted to the left.
Demand curve has shifted to the right.
Demand curve has shifted to the left.
Supply curve has shifted to the right.
Demand curve happens to be upward sloping.
M7       As a result of standardized products, under perfect competition
Firms are confronted by diminishing returns.
Firms will seek to attain quality advantages.
Firms face perfectly elastic individual demand curves.
Firms face perfectly inelastic demand curves.
Firms are forced to advertise.
M8       A firm under perfect competition sells 100 units of output at $7 per unit. If it expands production to 120 units, its marginal revenue is
$3.50 per extra unit sold.
More than $7 per extra unit sold.
$700 in total.
Exactly $7 per extra unit sold.
Impossible to determine without further information.
M9       An accurate description of a perfectly competitive industry is
A limited number of firms producing standardized products.
A large number of small firms producing standardized products.
A large number of small firms producing differentiated products.
A small number of large firms producing either standardized or differentiated products.
Large-scale firms producing at minimum average cost per unit.
M10     In order to maximize profit, a firm under perfect competition should continue production until the extra cost of producing the last unit of output
Is stabilized.
Begins to rise.
Begins to decline.
Is equal to average variable cost.
Is equal to the market price.
M11     A perfectly competitive industry may be able to expand along a horizontal long-run supply curve.  Such an industry is known as a
Constant-cost industry.
Increasing-cost industry.
Decreasing-cost industry.
Dynamic industry.
An industry with increasing returns to scale.
M12     The demand curve faced by a firm in a perfectly competitive industry is
The same as the market demand.
The same as the market supply.
The same as the market price.
Always above the marginal revenue curve.
Downward sloping.
M13     In the long run, perfectly competitive firms are at equilibrium when
P = LMC > LAC.
P = MR.
P = LAC > LMC.
P = LMC = LAC.
R = VC.
M14     In a constant cost industry, a permanent fall in demand will cause
A drop in price in the long run.
A reduction in the number of firms in the long run.
No change in equilibrium price in the long run.
No change in the output per firm in the long run.
Answers b, c, and d are all correct.
M15     The idea behind the concept of the “invisible hand” is that
Competitive markets maximize shareholder welfare.
Government intervention is necessary to correct market outcomes.
Competitive markets are efficient, i.e. maximize social welfare.
Government regulations necessarily distort social welfare.
Competitive markets are fair, but not necessarily efficient.
M16     The net “gain” a buyer of a good obtains is called
Consumer surplus.
Producer surplus.
Social welfare.
The terms of trade
M17     The efficient industry outcome under perfect competition occurs at an output where
            a.         MR = MC.
            b.         MB = P = MC.
            c.         P  >  MC.
            d.         Consumer Surplus = Industry Profit.
            e.         Consumers attain a partial price subsidy from the government.
M18     Consumers who are priced out of the market because their MB < PC
            a.         represent a source of inefficiency.
            b.         are consistent with an efficient market outcome.
            c.         should be subsidized by the government.
            d.         should strive to increase their MB and purchase the good.
            e.         Answers a and c are both correct.
M19     Competition on the internet
            a.         achieves perfect competition.
            b.         increases competition by reducing consumer search costs.
            c.         allows firms to charge optimal markups for differentiated products.
            d.         Answers b and c are both correct.
            e.         None of the answers above is correct.
M20     Trade between nations usually means that
One country is richer than the other.
One country becomes richer while the other becomes poorer.
Both trading nations benefit.
One trading country is trying to “beggar its neighbor.”
The nation with a trade surplus gains; the side with a trade deficit loses.
M21     When all trade is prohibited in good X, the equilibrium price in the home country is Px. After free trade is instituted, domestic producers (with upward sloping supply curves) begin to export good X to the rest of the world. Therefore,
The domestic price of good X will fall.
The domestic price of good X will rise.
The domestic price of good X will exceed the price in foreign countries.
The domestic price of good X will be less than the price in foreign countries.
One cannot predict the impact on the price of the commodity.
Short Problems and Questions
S1        In a given market, demand is described by the equation QD = 900 – 5P and supply is described by QS = 100 + 5P.
a.         Determine the equilibrium price and quantity.
Determine the surplus or shortage that would exist if the price were $100.
S2        A perfectly competitive industry has 50 identical firms producing a standardized product. The market demand for the good is P = 1,000 – 20Q, and the industry supply is
P = 100 + Q. Find the profit-maximizing price and output of each identical firm.
S3        In a perfectly competitive market, LAC = LMC = $5 per unit for the typical firm. However, one of the firms discovers a technological innovation lowering its AC and MC to $4.50. How will this affect the equilibrium price? If all firms can take advantage of the innovation, what is the impact on the market price and industry profits?
S4        A perfectly competitive market is characterized by identical firms, each having a marginal cost of $50. The equilibrium price in the short run is P = $60. Do you expect the number of firms to remain the same in the long run? Explain.
S5        In a perfectly competitive market, the equilibrium price is $20. What is the demand curve faced by a typical firm? If one firm decided to charge P = $19.90, what would be the firm’s demand? The demand for the other firms in the market?
S6        Describe a perfectly competitive firm’s short-run supply curve. On what is it based?
S7        In a long-run equilibrium, there are no economic profits under perfect competition. Then, why do firms continue to produce?
S8        Would a firm in a perfectly competitive industry typically display increasing, decreasing, or constant returns to scale? Explain.
S9        A perfectly competitive market is in competitive equilibrium and the resulting output is economically efficient. But now there is a significant drop in industry demand resulting in a new equilibrium price and quantity? Explain the efficiency (or inefficiency) of the new equilibrium.
Longer Problems and Discussion Questions
L1        Which of the following industries are likely to be perfectly competitive? Of those that are not, explain why they are not.
Food retailing
Automobile manufacturing
National agricultural markets
Local banking
L2        Suppose that in some market, demand can be described with the equation Q = 900 – 5P and supply can be described with the equation Q = 100 + 5P. Complete the following table, and determine the equilibrium price and quantity.
Quantity Demanded
Quantity Supplied
L3        In a competitive industry, the short run average variable cost of a firm (producing output q)
is:                                             AVC = 600 – 20q +.5q2.
a.         Derive the firm’s short run supply equation.
b.         Determine the minimum possible price for the firm in the short run.
L4        In a competitive market, there are 8 firms, each with total cost given by: C = q2 + 100.
            a          Derive the firm’s long-run supply equation and the market supply equation.
b          Market demand is given by Q = 120 – P. Determine the equilibrium price and total output in the market. What is each firm’s output and economic profit?
c          In the long-run, is the number of firms likely to increase or to decrease? In the long-run equilibrium, determine price, total output, and the number of firms.
L5        Explain how competitive markets provide efficient levels of output and services. What role does the rule, MB = MC, play?
L6.       A perfectly competitive market has constant long-run average cost, LAC = LMC = $6 per unit and has industry demand curve: P = 12 – .2Q, where Q is denoted in thousands of units.
Determine output, price, consumer surplus and producer profit.
Suppose that the industry were to become monopolized, so that the new price and output were P = $9 and Q = 15 thousand units. Recalculate consumer surplus and producer profit. Compare total welfare in parts b and a.
L7        Two neighboring states have separate commodity exchanges for buying and selling natural gas. Supply and demand determine prevailing prices in each state, but by law, gas could not be bought or sold between the states. Typically, the prevailing price in the northern state was about 1.5% higher than in the southern state. Why might this be the case? Recently, the states agreed to create a single natural gas exchange for the two states. Explain why this would increase overall economic efficiency.
L8        A small nation sets a tariff on an imported good. At the current price, P = $12, domestic firms supply 5 million units and imports account for 4 million units. Removing the tariff would spur a price reduction to P = $10, causing domestic supply to fall to 3 million units and imports to increase to 8 million units.
a.         Draw a demand-supply diagram showing the industry at both the $12 and $10 prices.
b.         On your diagram, show the net welfare loss due to the tariff and compute its dollar size.
L9        The passage of NAFTA in Fall 1993 increased trade among Canada, Mexico, and the United States due to the lowering of tariffs and other trade barriers. Using a demand-supply diagram, show the effects on a Mexican market that exports goods under free trade. Trace the effects on consumer surplus and producer profit to show that total welfare has increased in this new export market.

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