… a core topic in Economic Analysis and Atlas102
This topic deals with costs and profit maximization under competition.
The treatment of this topic on the Atlas follows almost precisely that in Chapter 9, Costs and Profit Maximization Under Competition , and Chapter 10, Competition and the Invisible Hand , of the open access Principles of Microeconomics course offered by Tyler Cowen and Alex Tabarrok at the Marginal Revolution University online education platform (http://www.mruniversity.com/courses/principles-economics-microeconomics , accessed 7 May 2016).
Topic learning outcome Appropriately utilize and interpret results of applying the principles of producer theory and competition, including the identified core concepts, to the analysis of public policy and management problems.
Core concepts associated with this topic Readings
We believe that this topic and its core concepts can be mastered to the MPP/MPA level by watching and re-watching the 72 minutes of MRU course videos listed below and doing the 43 sample questions associated with these video segments and reproduced at the bottom of this page and repeated on the appropriate concept pages.
Atlas pages: Competition and Theory of the Firm and associated Concepts.
Alex Tabarrok, Introduction to the Competitive Firm (7-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/deeper-look-tradeable-allowances , accessed 6 May 2016.
Alex Tabarrok, Maximizing Profit under Competition (13-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/deeper-look-tradeable-allowances , accessed 6 May 2016.
Alex Tabarrok, Maximizing Profit and the Average Cost Curve (12-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/profit-maximization-average-cost , accessed 6 May 2016.
Alex Tabarrok, Entry, Exit, and Supply Curves: Increasing Costs (7-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/profit-maximization-average-cost , accessed 7 May 2016.
Alex Tabarrok, Entry, Exit, and Supply Curves: Constant Costs (10-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/supply-curve-constant-cost-industry , accessed 7 May 2016.
Alex Tabarrok, Entry, Exit, and Supply Curves: Decreasing Costs (6-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/supply-curve-decreasing-cost-industry , accessed 7 May 2016.
Alex Tabarrok, Minimization of Total Industry Costs of Production (9-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/minimizing-industry-costs-production-invisible-hand , accessed 7 May 2016.
Alex Tabarrok, The Balance of Industries and Creative Destruction (8-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/creative-destruction-definition-elimination-principle , accessed 7 May 2016.
Textbook readings in MPP and MPA courses
University of Toronto PPG1002
Varian, Hal R., and Jack Repcheck. Intermediate microeconomics: a modern approach. Vol. 6. New York, NY: WW Norton & Company, 2010. Chapter 19
Carleton University PADM5111
Frank, Robert, Ian Parker, and Igela Alger. Microeconomics and Behaviour, 5th Canadian Edition. New York: McGraw-Hill, 2013. Chapters 9 and 10
Harvard Kennedy School API101
Pindyck, Robert S. and Daniel L. Rubinfeld. Microeconomics, 8th Edition. Prentice-Hall, 2012. Chapters 6 and 7 (pp. 229-258)
NYU Wagner GP1018
Krugman, Paul and R. Wells, Microeconomics, 3rd edition. London: Worth Publishers, 2012. Chapters 9 (up to pg. 258), 11 (up to pg. 333), and 12
Ford School of Public Policy: Public Policy 555
Pindyck, Robert S., and D. Rubinfeld. Microeconomics, 7th edition. Upper Saddle River: Patience-Hall, 2007. Chapter 6
George Washington: PPPA-6003
Mankiw, N. Gregory. Principles of Microeconomics , 6th edition. Mason: South-Western College Publishers, 2011. Chapters 13 and 14
Wheelan, Charles. Naked Economics: Undressing the Dismal Science. New York: W. W. Norton & Company, 2010. Chapter 2
American PAUD630
Krugman, Paul and R. Wells, Microeconomics, 3rd edition. London: Worth Publishers, 2012. Chapter 9 and 11
UCLA Luskin PLC201
Goolsbee, Austan, Steven Levitt, and Chad Syverson. Microeconomics. New York: Worth Publishers, 2013. Chapter 6
Rutgers Economics in Public Policy
Pindyck, Robert S., and D. Rubinfeld. Microeconomics, 7th edition. Upper Saddle River: Patience-Hall, 2007. Chapters 7 and 8
Assessment questions (from MRU Practice Questions for Chapter 4)
From http://www.mruniversity.com/node/230468 , http://www.mruniversity.com/node/230512 , http://www.mruniversity.com/node/264181 , http://www.mruniversity.com/node/264285 , http://www.mruniversity.com/node/264309 , http://www.mruniversity.com/node/267267 , accessed 3 May 2016.
AQ102.08.01. A competitive firm maximizes profit by choosing
Price
Quantity
Both price and quantity
Either price or quantity, but not both
None of the above.
AQ102.08.02. A competitive market has which of the following characteristics?
a. Lots of small-scale sellers
b. Lots of small-scale buyers
c. Product that is similar across sellers
d. a and c only
e. All of the above.
AQ102.08.03. In a competitive market, sellers sell their product
At the world price.
Just below the world price.
Just above the world price.
AQ102.08.04. On January 27, 2011, the price of Ford Motor Company stock hit an almost 10-year high at $18.79 per share. (Two years prior, in January 2009, Ford stock was trading for about a tenth of that price.) Suppose that on January 27, 2011, you owned 10,000 shares of Ford stock (a small fraction of the almost 3.8 billion shares). Suppose you offered to sell your stock for $18.85 per share, just slightly above the market price. How many shares would you sell?
10,000
7,300
1
0
AQ102.08.05. Suppose instead that on January 27, 2011, you wanted to sell your 10,000 shares of Ford stock but you reduced your asking price to $18.75 per share? How many shares would you sell?
10,000
7,300
1
0
AQ102.08.06. Given your answer to the previous question, should you sell your shares at $18.75?
Yes
No
AQ102.08.07. Which characteristic below best describes the demand curve that you as an individual seller of Ford stock face?
A perfectly elastic demand curve
A perfectly inelastic demand curve
None of the above.
AQ102.08.08. The economic definition of profit differs from the accounting definition of profit in that the economic definition includes
Fixed costs
Variable costs
Opportunity costs
Sunk costs
None of the above
AQ102.08.09. Whenever money is used to purchase capital, interest costs are incurred. Sometimes those costs are explicit—like when Alex borrowed the money from the bank—and sometimes those costs are implicit— like when Tyler had to forgo the interest he could have earned had he left his funds in a savings account. If an economist and accountant calculated Alex and Tyler’s costs, for whom would they have identical numbers and for whom would the numbers differ?
Economist and accountant would agree on Alex’s costs and disagree on Tyler’s.
Economist and accountant would agree on Tyler’s costs and disagree on Alex’s.
AQ102.08.10. In the aforementioned disagreement on cost of one of the activities, which profession would calculate a larger cost?
Economist
Accountant
AQ102.08.11. Which type of cost is dependent on the amount of quantity produced by a firm?
fixed costs
variable costs
sunk costs
none of the above
AQ102.08.12. A competitive firm maximizes profit by choosing a level of output where the world price is equal to the firm’s
Marginal revolution
Marginal revenue
Marginal cost
Average cost
Fixed costs
Variable costs
AQ102.08.13. True or False: When a competitive firm maximizes profit, profits are always greater than 0.
True
False
AQ102.08.14. Paulette, Camille, and Hortense each own wineries in France. They produce inexpensive, mass-market wines. Over the last few years, such wines sold for 7 euros per bottle; but with a global recession, the price has fallen to 5 euros per bottle. Given the information below, let’s find out which of these three winemakers (if any) should shut down temporarily until times get better. Remember: Whether or not they shut down, they still have to keep paying fixed costs for at least some time (that’s what makes them “fixed”). To keep things simple, let’s assume that each winemaker has calculated the optimal quantity to produce if they decide to stay in business; your job is simply to figure out if she should produce that amount or just shut down. Which of these women, if any, earned a profit?
Paulette
Camille
Hortense
Paulette and Camille only
None of the women earned a profit
AQ102.08.15. Who should stay in business in the short run?
Paulette
Camille
Hortense
Paulette and Camille only
None of the wineries
AQ102.08.16. For which of these wineries, if any, is P > AC? (Hint: You don’t need to calculate any new numbers to answer this.)
Paulette
Camille
Hortense
Paulette and Camille only
None of the wineries
AQ102.08.17. Fill in the blank: Even if profit is negative, if revenues are ______ variable costs, then it’s best to stay open in the short run.
>
<
AQ102.08.18. You’ve been hired as a management consultant to WaffleCo, a maker of generic-brand frozen waffles. They’re each trying to figure out if they should produce a little more output or a little bit less in order to maximize their profits. The firms all have typical marginal cost curves: They rise as the firm produces more. Your staff did all the hard work for you of figuring out the price of the firm’s output is $4 per box and the marginal cost of producing one more unit of output is $2 per box at its current level of output. However, they forgot to collect data on how much the firm is actually producing at the moment. Fortunately, that doesn’t matter. In your final report, you need to decide if the firm should produce more, less, or stay at the current output level. What do you recommend?
Produce more
Produce less
Stay at the current level of output
AQ102.08.19. For a competitive firm supplying wheat, if the world price (P) equals the firm’s min average cost (min AC), then profits will be
greater than 0
less than 0
0
Indeterminate from the given information.
AQ102.08.20. Given the cost function for Simon, a housepainter in a competitive local market, below, answer the questions that follow. (You may want to calculate average cost.) What is the minimum price per room at which Simon would be earning positive economic profit?
$62.51
$48.34
$60.01
$76.68
$35.
AQ102.08.21. What is the least common cost structure for an industry?
Costs decrease as industry output increases
Costs increase as industry output increases
Costs stay the same as industry output increases
AQ102.08.22. In the ancient Western world, incense was one of the first commodities transported long distances. It grew only in the south of the Arabian Peninsula (modern-day Yemen, known then as Arabia Felix) and was transported by camel to Alexandria and the Mediterranean civilizations, notably the Roman Republic. As the republic expanded into a richer and larger empire, the demand for incense grew and planters in Arabia added a second and then a third annual crop (though this incense was not as high of a quality). Cultivation also crossed to the Horn of Africa (modern-day Oman) even though such fields were farther away from Rome. The fact that additional annual crops were of lower quality indicates that this industry has
Increasing costs
Decreasing costs
Constant costs
Indeterminate from the given information
AQ102.08.23.1 It’s more costly to grow incense in Eastern Africa than in Arabia Felix. Which region would you expect to see more incense grown in?
Eastern Africa
Arabia Felix
AQ102.08.23.2 In the long run, constant supply curves are:
sloping upwards
horizontal
sloping downwards
AQ102.08.24. In the competitive children’s pajama industry, a new government safety regulation raises the average cost of children’s pajamas by $2 per pair. If this is a constant cost industry, then in the long run, what exactly happens to the price of children’s pajamas?
The price of pajamas increases by more than $2
The price of pajamas increases by less than $2
The price of pajamas increases by exactly $2
AQ102.08.25. If this is an increasing cost industry instead, will the long-run price of pajamas rise by more than $2 or less? (Hint: The long-run supply curve will be shaped just like an ordinary supply curve. If you treat this like a $2 tax per pair, you’ll get the right answer.)
The price of pajamas increases by more than $2
The price of pajamas increases by less than $2
The price of pajamas increases by exactly $2
AQ102.08.26. As Ngoy started hiring more Cambodian refugees to work in his donut shop, this made it more likely that
Competition from other doughnut shop owners would increase
Ngoy’s fixed costs decreased
Other Cambodians would open donut shops
AQ102.08.27. At this point in the story, what sort of cost industry (constant, increasing, or decreasing) would you consider doughnut shops owned by Cambodians to be?
Constant
Increasing
Decreasing
AQ102.08.28. Fast forward 40 years: What kind of cost structure are Californian doughnut shops probably in now?
Constant
Increasing
Decreasing
AQ102.08.29. We mentioned that carpet manufacturing looks like a decreasing cost industry. In American homes, carpets are much less popular than they were in the 1960s and 1970s, when “wall-to-wall carpeting” was fashionable in homes. Suppose that carpeting became even less popular than it is today: What would this fall in demand probably do to the price of carpet in the long run?
Increase carpet prices
Decrease carpet prices
No change to carpet
AQ102.08.30. Entrepreneurs shift capital and labor across industries in pursuit of profit. Let’s look at this a little more closely. Suppose there are two industries: a high-profit industry, Industry H, and a low-profit industry, Industry L. Answer the questions below about these two industries. If the two industries have similar costs, then what must be true about prices in the two industries?
Prices in Industry H are higher than in Industry L
Prices in Industry H are lower than in Industry L
Indeterminate from the given information
AQ102.08.31. Suppose instead that the prices in the two industries were identical. In this case, what must be true about the costs in the two industries?
Costs in Industry H are higher than in Industry L
Costs in Industry H are lower than in Industry L
Indeterminate from the given information
AQ102.08.32. Assuming that prices in the two industries were identical, if labor and capital are moved from Industry L to Industry H, are more units of output lost in Industry L or gained in Industry H?
More units of output are lost in Industry L than are gained in Industry
More units of output are gained in Industry H than are lost in Industry
Indeterminate from the given information
AQ102.08.33. Suppose that two industries, the pizza industry and the calzone industry, are equally risky, but rates of return on capital investments are 5% in the pizza industry and 8% in the calzone industry. Which way will capital flow—from the pizza industry to the calzone industry, or from the calzone industry to the pizza industry?
From pizza industry to calzone industry
From calzone industry to pizza industry
Indeterminate from the given information
AQ102.08.34. We’ve claimed that the efficient way to spread out work across firms in the same industry is to set the marginal cost of production to be the same across firms. Let’s see if this works in an example. Consider a competitive market for rolled steel (measured by the ton) with just two firms: SmallCo and BigCo. If we wanted to be more realistic, we could say there were 100 firms like SmallCo and 100 firms like BigCo, but that would just make the math harder without generating any insight. (We’ll also ignore fixed costs of starting up the firms just to make things a little simpler. ) The two firms have marginal cost schedules like this: What is the total cost of SmallCo producing 6 units of output?
$60
$130
$150
$210
$280
AQ102.08.35. What is the total cost of BigCo producing 6 units of output?
$30
$60
$90
$120
$130
AQ102.08.36. What would the price have to be in this competitive market for these two firms to produce a total of 11 tons of steel?
$30
$40
$50
$60
Indeterminate from the given information
AQ102.08.37. What would the total cost be if BigCo were the only firm in the market, and it had to produce 7 tons of rolled steel?
$40
$70
$130
$140
$170
AQ102.08.38. What would total cost be if SmallCo and BigCo let the invisible hand divvy up the work between them to produce 7 tons of rolled steel?
$20
$30
$70
$90
$130
AQ102.08.39. Would it make sense to shut down the more inefficient of the two firms?
Yes
No
AQ102.08.40. Let’s review the basic mechanism of the elimination principle with the following questions. When demand rises in Industry X, what happens to profits? Do they rise, fall, or remain unchanged?
Rise
Fall
Remain unchanged
AQ102.08.41. When that happens, do firms, workers, and capital tend to enter Industry X, or do they tend to leave?
Enter
Exit
No changes
AQ102.08.42. Does this tend to increase short-run supply in Industry X or reduce it?
Increase
Reduce
AQ102.08.43. In the long run, after this rise in demand, what will profits typically be in Industry X?
Greater than 0
0
Less than 0
Indeterminate from the given information.
Page created by: Ian Clark, last modified on 16 May 2016.
Image: Minute 11:39 of MRU Video, at http://www.mruniversity.com/courses/principles-economics-microeconomics/profit-maximization-marginal-cost-marginal-revenue , accessed 3 May 2016.
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