Question 1

Entry of new firms in an increasing-cost industry leads to an upward shift of the LRAC curve.

Accepted Answer

In an increasing-cost industry, as more firms enter the industry, the cost of production increases due to the scarcity of resources. This leads to an upward shift of the long-run average cost (LRAC) curve, making it more expensive for firms to produce the same amount of output. Therefore, the statement is true.

Question 2

The owner of Tie-Dyed T-shirts, a perfectly competitive firm, hires you to give him economic advice. He tells you that the market price for his shirts is $15 and that he is currently producing 200 shirts at an AVC of $10 and an ATC of $20. You tell him he should continue to operate in the short run because
A) he is earning an economic profit of $4,000.
B) his loss from operating in only $2,000 which is less than his loss if he shuts down.
C) he has to pay this fixed costs of $2,000 if he shuts down which is greater than his loss when he operates.
D) In fact you do not tell him to operate-he should shut down since he has a loss.

Accepted Answer

The answer of The owner of Tie-Dyed T-shirts, a perfectly...

Question 3

For a perfectly competitive industry, diminishing marginal returns
A) occur only in the short run.
B) occur only in the long run.
C) occur in both the short run and in the long run.
D) Diminishing marginal returns do not occur in perfectly competitive industries.

Accepted Answer

Diminishing marginal returns occur in the short run because, in the short run, at least one factor of production is fixed. As more units of a variable input (like labor) are added to a fixed input (like capital), the additional output produced by each additional unit of the variable input eventually decreases. This concept does not directly apply to the long run, where all factors of production can be varied.

Question 4

At all prices below the shutdown point, optimal short-run output is zero.

Accepted Answer

The shutdown point is the point below which a firm should cease production in the short run. Therefore, at all prices below this point, it is optimal for the firm to produce zero output.

Question 5

Entry of new firms in an decreasing-cost industry leads to an upward shift of the LRAC curve.

Accepted Answer

In a decreasing-cost industry, the entry of new firms typically leads to a downward shift of the LRAC curve due to economies of scale and increased efficiency.

Question 6

In the short run, firms suffering losses should always shut down.

Accepted Answer

Firms should only shut down in the short run if their variable costs are greater than their total revenue. Otherwise, they should continue operating in the short run to cover as much of their fixed costs as possible. In the long run, firms may need to exit the market if they continue to incur losses.

Question 7

A perfectly competitive firm is breaking even. In the short run it should ________. In the long run it should ________.
A) shut down; expand
B) produce where MC = MR; leave the industry
C) produce where MC = MR; keep the same production level
D) shut down; exit the industry

Accepted Answer

Since the firm is breaking even, its total revenue is equal to its total cost. In the short run, the firm should produce where marginal cost (MC) is equal to marginal revenue (MR) in order to maximize its profits. If it were to shut down, it would still incur its fixed costs, resulting in further losses. Therefore, option A and D can be eliminated. Similarly, in the long run, if the firm is making zero economic profit, it should continue producing at the same level to cover all of its costs as there are no profits to reinvest in expanding the business. Therefore, option C is the most appropriate choice. Option B is incorrect because if the firm leaves the industry, it wouldn't be able to cover its fixed costs which would lead to further losses.

Question 8

If price is above average total cost at the output where marginal revenue equals marginal cost, a firm will earn positive economic profits.

Accepted Answer

If price is above average total cost, the firm is earning a profit. If the output where marginal revenue equals marginal cost is also profitable, then the firm is earning positive economic profits.

Question 9

When price is sufficient to cover average variable costs, firms suffering short-run losses will continue to operate rather than shut down.

Accepted Answer

As long as price is sufficient to cover average variable costs, firms will continue to operate in the short run, even if they are experiencing losses. This is because shutting down would result in incurring additional costs. It is only in the long run, when all costs become variable, that a firm will shut down if it cannot cover its total costs.

Question 10

Input prices rise as entry occurs in an constant-cost industry.

Accepted Answer

In a constant-cost industry, there is no change in the prices or input costs as new firms enter the market. This is because the industry supply curve remains constant, and any increase in demand is met with an increase in supply at the same input prices. Therefore, the entry of new firms does not affect input prices.

Question 11

The owner of Tie-Dyed T-shirts, a perfectly competitive firm, hires you to give him economic advice. He tells you that the market price for his shirts is $15 and that he is currently producing 200 shirts at an AVC of $10 and an ATC of $20. What would you recommend that he do?
A) Continue producing in the short run, as his loss from production is less than his fixed costs, but exit the industry in the long run if there are no changes in economic conditions.
B) Shut down in the short run, as he is incurring a loss, and leave the industry in the long run, if there are no changes in economic conditions.
C) Continue to produce in the short run, even though he is earning a loss, and expand production in the future hoping to increase market share and total revenue.
D) Tell him that you cannot make any recommendations until you know what his fixed costs are.

Accepted Answer

In the short run, the firm should continue producing as long as the price covers the average variable cost (AVC), which is $10, even though the average total cost (ATC) is $20, indicating a loss. This is because by continuing to produce, the firm can cover its variable costs and contribute to fixed costs, minimizing losses compared to shutting down immediately. However, if the situation doesn't improve, exiting the industry in the long run would be advisable since the firm cannot cover its total costs in the long term at the current price.

Question 12

Information on MC of production is all that is necessary to obtain the long run industry supply curve, because P = MC is the profit-maximization condition for all firms.

Accepted Answer

The long-run industry supply curve requires information beyond just the marginal cost (MC) of production, including factors like technology, input prices, and market entry and exit, as these affect the overall supply conditions and costs in the long run.

Question 13

If, at the output where marginal revenue equals marginal cost, price is between average total cost and average variable cost, a firm will continue to produce in the short run.

Accepted Answer

In the short run, a firm will continue to produce as long as price is greater than or equal to average variable cost, which means it is covering its variable costs. If price is also between average variable cost and average total cost, the firm is also covering its fixed costs and may be earning some economic profit. Therefore, the firm will continue to produce as long as it is profitable. The condition of marginal revenue equaling marginal cost ensures that the firm is maximizing its profit.

Question 14

Input prices fall as entry occurs in an decreasing-cost industry.

Accepted Answer

In a decreasing-cost industry, as new firms enter the market, the average cost of production for all firms decreases due to economies of scale. This allows firms to charge lower prices while still making a profit, leading to lower input prices.

Question 15

The long run industry supply curve is made up of the zero-profit equilibrium levels of output as the industry expands due to entry of new firms.

Accepted Answer

This statement accurately describes the concept of the long run industry supply curve, which represents the minimum average total cost necessary for firms to continue producing in the long run, and is determined by the zero-profit equilibrium levels of output as the industry grows or contracts due to entry or exit of firms.

Question 16

A firm must earn an economic profit in order to receive a normal rate of return.

Accepted Answer

A normal rate of return is the minimum rate of return necessary to keep investors satisfied and willing to continue investing in the firm. Therefore, a firm can receive a normal rate of return without earning economic profit as long as it covers its costs and provides the expected rate of return to investors.

Question 17

The marginal cost curve of a firm above AVC is also its short-run supply curve.

Accepted Answer

In the short run, a firm will only produce if the price of its product covers at least its variable costs (AVC). Therefore, the portion of the marginal cost curve above the AVC curve represents the firm's willingness to produce at different prices. This makes it the firm's short-run supply curve.  So, the statement is true.

Question 18

Input prices fall as entry occurs in an increasing-cost industry.

Accepted Answer

In an increasing-cost industry, the cost of producing each unit increases as more firms enter the market. This leads to a shift in the industry's supply curve to the left, causing an increase in equilibrium price and a decrease in equilibrium quantity. Therefore, input prices are unlikely to fall as entry occurs in an increasing-cost industry.

Question 19

The horizontal sum of marginal cost curves (above AVC) of all the firms in an industry is the short-run industry supply curve.

Accepted Answer

This statement is true. The short-run industry supply curve is the sum of the marginal cost curves of all the firms in the industry above their respective average variable cost (AVC) curves. This is because in the short run, firms can only adjust their production levels, and not their plant capacity. Thus, the industry supply curve reflects the total quantity of output that all the firms in the industry are willing and able to supply at different prices in the short run.

Question 20

If, at the output where marginal revenue equals marginal cost, price is below average variable cost, a firm will shut down in the short run.

Accepted Answer

When the price is below average variable cost, the firm is not covering its variable expenses and is incurring losses. In this situation, shutting down in the short run would minimize losses as the firm would avoid incurring fixed costs.

Quiz 9: Long-Run Costs and Output Decisions