Chapter 18 — Exercises

Section A — The competitive firm

A1. A firm in a perfectly competitive market faces a price of $15/unit. Its cost structure is: FC = $100, MC = 2 + 0.5Q. Find the profit-maximizing quantity. Compute the firm's profit.

A2. Using the same cost structure, suppose the price falls to $8. Find the profit-maximizing quantity. Is the firm profitable? Should it shut down? (Compute min AVC first.)

A3. Why does MR = P for a price-taking firm but MR < P for a monopolist?

A4. "A competitive firm has no pricing strategy — it just produces where P = MC." Is this a simplification, or is it literally true? Explain.

Section B — Short-run equilibrium

B1. A market has 100 identical competitive firms, each with MC = 10 + Q and AVC = 10 + Q/2. The market demand is Q_d = 2000 − 50P. Find: (a) Each firm's supply curve. (b) The market supply curve. (c) The equilibrium price and quantity. (d) Each firm's output and profit.

B2. In the market from B1, demand suddenly doubles (Q_d = 4000 − 50P). What happens in the short run (before entry)? What happens in the long run (after entry)?

B3. Draw a diagram showing a competitive firm earning positive economic profit in the short run. Label P, MC, ATC, AVC, Q*, and the profit rectangle.

B4. Draw a diagram showing a competitive firm earning negative economic profit (a loss) in the short run but still operating. Why doesn't the firm shut down?

Section C — Long-run equilibrium

C1. Explain the entry-exit mechanism that drives economic profit to zero. Walk through the steps for a market where firms are initially earning positive profit.

C2. "Zero economic profit means the firm is barely surviving." True or false? Explain carefully.

C3. In long-run equilibrium, P = min ATC. Why this specific point? Why not some other point on the ATC curve?

C4. A new technology reduces every firm's ATC by $2 at every output level. What happens in the short run? In the long run? Does the price change? Does the number of firms change?

C5. A permanent increase in demand shifts the demand curve right. What happens to: (a) price in the short run, (b) economic profit in the short run, (c) entry in the long run, (d) price in the long run, (e) the number of firms in the long run?

Section D — Application: Millbrook agriculture

D1. Corn farming in the Walden County area around Millbrook is close to perfectly competitive. Explain why each of the four assumptions approximately holds for this market.

D2. In 2024, corn prices rose because of a drought in the Midwest. What happened to each farmer's short-run profit? What does the model predict for long-run entry?

D3. "A single corn farmer in Iowa has no market power — she's a pure price taker." Is this literally true? What small deviations from perfect competition exist even in commodity agriculture?

Section E — The supply curve

E1. Why is the firm's supply curve its MC curve above AVC (and not above ATC)?

E2. Why is the market supply curve the horizontal sum of all individual firms' MC curves?

E3. When new firms enter a market, what happens to the market supply curve? What happens to the price?

Section F — Policy debate

F1. "Competitive markets produce zero economic profit, which means firms can't invest in innovation." Evaluate. Is zero economic profit compatible with innovation?

F2. "If farming is perfectly competitive and farmers earn zero economic profit, why do people farm?" Answer using the distinction between economic and accounting profit.

F3. "Government price supports for agricultural products keep farmers profitable." Apply the competitive model. What do price supports do to supply, entry, and long-run equilibrium?

Section G — Reflection

  • The zero-profit result is one of the most powerful and surprising results in microeconomics. Did you find it surprising? Does it make sense intuitively?
  • Why do we study perfect competition if no real market is perfectly competitive?
  • Compare the competitive benchmark to your own experience as a consumer. Do you think the markets you participate in are approximately competitive? Which ones are closest, which are farthest?

Selected answers in appendices/answers-to-selected.md.