Economics 102 Study Notes
Economics 102 Fall 2023 Third Hourly Examination Study Notes
Section I: Multiple Choice Questions
1. Objective of the Firm
The goal of the firm in economic theory is to:-
(d) maximize profits.
Explanation: Firms aim to maximize their profits as this is typically their primary motivator, influencing decisions related to production, pricing, and resource allocation.
2. Marginal Cost (MC)
Marginal cost is defined as:-
(b) the additional cost incurred by increasing output by one unit.
Explanation: MC reflects the change in total cost resulting from producing one more unit of a good or service.
3. Marginal Revenue (MR)
Marginal revenue is:-
(b) the addition to a firm's total revenue that comes from selling one more unit of output.
Explanation: This indicates how much additional revenue is generated when a firm sells one more unit of its product, which is critical in pricing decisions.
4. Profit-Maximizing Quantity from a Figure
From the figure provided, the profit-maximizing quantity of output is:-
(c) 13.
5. Price Charged by a Profit Maximizing Firm
The price that would be charged by a profit maximizing firm, according to the figure, is:-
(b) $8.
6. Total Profits at Profit-Maximizing Quantity
Total profits at the profit-maximizing quantity of output are:-
(c) $150.
7. Characteristics of a Perfectly Competitive Market
A perfectly competitive market consists of:-
(d) many firms selling identical products.
Explanation: Numerous firms compete by offering products that are virtually indistinguishable from one another.
8. Firm with a Horizontal Demand Curve
The type of firm that faces a horizontal demand curve is:-
(e) a perfectly competitive firm.
Explanation: In perfect competition, individual firms are price takers with no market power, leading to a horizontal demand curve.
9. Economic Profit Calculation
For Josh's Fashions, the economic profit earned when marginal cost is $25 and average total cost is $10 while producing 200 units is:-
Economic Profit = (Price - Average Total Cost) * Quantity
Calculation:
Price = MC = $25
ATC = $10
Economic Profit = ($25 - $10) * 200 = $3,000
Answer: (d) $3,000.
10. Individual Firm’s Supply Curve
An individual perfectly competitive firm’s supply curve is its:-
(e) marginal cost curve.
Explanation: The supply curve for an individual firm represents the minimum price at which it is willing to produce different quantities of goods, which is determined by its marginal cost.
11. Zero Economic Profits in the Long Run
Perfectly competitive firms earn only zero economic profits in the long run because:-
(e) there is free entry and exit of firms.
Explanation: The presence of free entry and exit ensures that any economic profits attract new firms, thus shifting the supply curve until profits are normalized to zero.
12. Characteristics of a Monopolistic Market
A monopolistic market consists of:-
(e) one firm producing all of the output in the market.
Explanation: Monopoly exists when a single firm dominates the market, becoming the sole producer of a product.
13. Demand Curve for a Monopolist
The monopolist’s demand curve:-
(b) is the market demand curve.
Explanation: A monopolist faces the market demand curve entirely, significantly influencing price and output decisions.
14. Price Strategy for a Monopoly
If one inherits the only spring of mineral water in York County, to maximize profits, one would:-
(a) charge them the highest price possible to sell some output.
Explanation: A monopolist can set prices above marginal cost to maximize profits due to market control.
15. Monopoly vs. Competitive Firms
A monopoly is likely to:-
(a) produce less; charge more.
Explanation: By restricting output, a monopoly can raise prices, unlike competitive firms that produce at a level where price equals marginal cost.
16. Monopolistic Competition Characteristics
A monopolistically competitive market consists of:-
(c) many firms selling slightly different products.
Explanation: These firms have some degree of market power due to product differentiation.
17. Price Increase Impact on Demand
If a monopolistically competitive firm raises its price, the quantity demanded:-
(c) will fall.
Explanation: Due to the availability of substitute products, a price increase leads to a decrease in the quantity demanded.
18. Definition of an Oligopoly
Oligopoly is defined as:-
(e) a market in which several large firms have all or most of the sales in an industry.
Explanation: Oligopolistic markets are characterized by a small number of firms that dominate the market share.
19. Collusion in Firms
Collusion occurs when:-
(a) firms act together to reduce output and keep prices high.
Explanation: Through collusion, firms can maintain higher prices than in competitive markets by strategically limiting output.
20. Market Structure with Minimum Prices
The market structure in which the largest quantity of output is sold at the minimum possible price is:-
(c) perfect competition.
Explanation: Perfect competition leads to an equilibrium where prices are driven down to the minimum average cost, enabling the most efficient allocation of resources.
Section II: Short Answer
Question: Briefly explain why a firm in a perfectly competitive market is a price taker.
Explanation: In a perfectly competitive market, numerous firms sell identical products, which results in all firms being price takers. This means that they cannot influence the market price; instead, they accept the market price determined by supply and demand forces. Since each firm’s output is a fraction of the total market supply, changes in their production do not affect the market price. Therefore, they sell their products at the prevailing market price, which is set by overall market conditions.
Section III: Diagramming
Task: Draw a graph of a perfect competitor in long-run equilibrium.
Graph Description: Below is a detailed description of the graph for a perfectly competitive firm in long-run equilibrium. This description should enable you to sketch the graph accurately.
Axes:
X-axis: Quantity of Output
Y-axis: Price and Cost
Curves and Lines:
The Demand Curve (D), Marginal Revenue Curve (MR), and Price (P) will be represented by a single horizontal line. This line should be clearly labeled as . It signifies that the firm is a price taker in the market, accepting the prevailing market price.
The Marginal Cost Curve (MC) should be U-shaped, indicating that marginal cost initially decreases with output and then increases. The MC curve should intersect the ATC curve at its minimum point.
The Average Total Cost Curve (ATC) should also be U-shaped. Initially, ATC is higher than MC, but MC eventually intersects the ATC curve at its minimum point, after which ATC rises.
Long-Run Equilibrium Point:
In long-run equilibrium for a perfectly competitive firm, economic profits are zero due to free entry and exit of firms. This condition is visually represented by the horizontal price line () being tangent to the absolute minimum point of the Average Total Cost (ATC) curve.
At this tangency point, the profit-maximizing quantity of output occurs where Marginal Revenue (MR) equals Marginal Cost (MC). Crucially, in long-run equilibrium, this point also corresponds to the minimum point of the ATC curve.
Therefore, the long-run equilibrium condition for a perfectly competitive firm is where: . This intersection point on the X-axis indicates the equilibrium quantity of output, and the corresponding value on the Y-axis indicates the equilibrium price and average total cost.
Total Profits:
At the profit-maximizing (and in long-run equilibrium, zero-economic-profit) quantity, the price charged by the firm is exactly equal to its average total cost. Thus, there is no area between the price line and the ATC curve to indicate positive or negative total economic profits; the firm earns only normal profit, which is considered part of the costs. This signifies that the firm is covering all its costs, including the opportunity cost of capital and labor, but is