The Theory of the Firm under Perfect Competition

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Learning Objectives

Understand the concept of profit maximization in a firm under perfect competition.
Identify the defining features of a perfectly competitive market.
Analyze the relationship between market price and average/marginal revenue for price-taking firms.
Explain the conditions for a profit-maximizing firm to produce positive output in both short run and long run.
Describe the firm's supply curve in the short run and long run.
Evaluate the effects of technological progress, input price changes, and unit taxes on a firm's supply curve.
Compute total revenue, marginal revenue, and average revenue from given data.
Calculate price elasticity of supply and interpret its significance.

Detailed Notes

The Theory of the Firm under Perfect Competition

4.1 Perfect Competition: Defining Features

Large number of buyers and sellers: Each is small compared to the market size.
Homogenous product: Products from different firms are identical.
Free entry and exit: Firms can easily enter or leave the market.
Perfect information: All buyers and sellers are fully informed about prices and products.

4.2 Revenue

Total Revenue (TR): TR = Market Price (p) × Quantity Sold (q)
Average Revenue (AR): For price-taking firms, AR = Market Price.
Marginal Revenue (MR): For price-taking firms, MR = Market Price.

4.3 Profit Maximisation

Profit: Profit = Total Revenue - Total Cost
Conditions for profit maximisation in the short run:
1. p = Short-run Marginal Cost (SMC)
2. SMC is non-decreasing
3. p ≥ Average Variable Cost (AVC)
Conditions for profit maximisation in the long run:
1. p = Long-run Marginal Cost (LRMC)
2. LRMC is non-decreasing
3. p ≥ Long-run Average Cost (LRAC)

4.4 Supply Curves

Short-run Supply Curve: Rising part of SMC curve above minimum AVC.
Long-run Supply Curve: Rising part of LRMC curve above minimum LRAC.

4.5 Determinants of a Firm's Supply Curve

Technological Progress: Shifts supply curve to the right (lower costs).
Input Prices: Increase in input prices shifts supply curve to the left (higher costs).
Unit Tax: Imposes additional cost per unit, shifting supply curve to the left.

4.6 Price Elasticity of Supply

Definition: Price elasticity of supply (es) = Percentage change in quantity supplied / Percentage change in price.
Example: If price rises from Rs 10 to Rs 30, and quantity supplied increases from 200 to 1000, then:
- Percentage change in quantity supplied = (1000 - 200) / 200 × 100 = 400%
- Percentage change in price = (30 - 10) / 10 × 100 = 200%
- Therefore, es = 400% / 200% = 2.

4.7 The Shut Down Point

Short Run Shut Down Point: Minimum AVC where SMC curve intersects AVC curve.
Long Run Shut Down Point: Minimum LRAC curve.

4.8 Normal Profit and Break-even Point

Normal Profit: Minimum profit needed to keep a firm in business, considered an opportunity cost.
Break-even Point: Point where a firm earns only normal profit, at minimum average cost.

Exam Tips & Common Mistakes

Common Mistakes and Exam Tips

Common Pitfalls

Misunderstanding Profit Maximization Conditions: Students often confuse the conditions for profit maximization. Remember, for a firm to maximize profit, the following must hold:
- Price (p) must equal Marginal Cost (MC)
- Marginal Cost must be non-decreasing at the profit-maximizing output level
- In the short run, price must be greater than Average Variable Cost (AVC); in the long run, price must be greater than Average Cost (AC).
Ignoring Market Structure Characteristics: When discussing perfect competition, students sometimes forget key characteristics:
- Large number of buyers and sellers
- Homogeneous products
- Free entry and exit from the market
- Perfect information
Confusing Short Run and Long Run Supply Curves: Students may mix up the definitions of short run and long run supply curves. Remember:
- Short run supply curve is based on the rising part of the Short Run Marginal Cost (SMC) curve above minimum AVC.
- Long run supply curve is based on the rising part of the Long Run Marginal Cost (LRMC) curve above minimum LRAC.

Exam Tips

Always Relate Revenue to Price: In a perfectly competitive market, remember that Total Revenue (TR) is calculated as TR = Price (p) × Quantity (q). This relationship is crucial for solving problems related to revenue.
Understand Elasticity: Be prepared to calculate the price elasticity of supply using the formula:

$e_s = \frac{\text{Percentage change in quantity supplied}}{\text{Percentage change in price}}$
Use Graphs Effectively: When asked to illustrate concepts like supply curves or profit maximization, use clear graphs to show the relationships between price, quantity, and costs.
Practice Calculation Problems: Familiarize yourself with calculating profit, total revenue, and marginal revenue from given data, as these are common exam questions.
Review Key Definitions: Make sure you can define and explain key terms such as normal profit, super-normal profit, and break-even point, as these are often tested.

Practice & Assessment

Multiple Choice Questions

Rs 5

Rs 10

Rs 15

Rs 20

Correct Answer: B

Solution:

The market price per unit is calculated as total revenue divided by the quantity sold. Therefore, the market price per unit is Rs 300 / 30 = Rs 10.

The supply curve shifts to the left.

The supply curve shifts to the right.

The supply curve remains unchanged.

The supply curve becomes vertical.

Correct Answer: B

Solution:

Technological progress allows a firm to produce more output with the same input, shifting the supply curve to the right.

The supply curve shifts to the right.

The supply curve shifts to the left.

The supply curve remains unchanged.

The supply curve becomes vertical.

Correct Answer: B

Solution:

An increase in the price of an input raises the firm's production costs, causing the supply curve to shift to the left.

Correct Answer: C

Solution:

The price elasticity of supply is calculated as the percentage change in quantity supplied divided by the percentage change in price. Here, the revenue triples as the price increases by 50%, so the elasticity is 3.

Continue production

Exit the market

Increase production

Decrease production

Correct Answer: B

Solution:

In the long run, a firm will produce only if the market price is greater than or equal to LRAC. Since the market price (Rs 25) is less than LRAC (Rs 30), the firm should exit the market.

The point where price equals average total cost.

The point where price equals marginal cost.

The point where price equals average variable cost.

The point where price equals average fixed cost.

Correct Answer: C

Solution:

The shut down point in the short run is where the price equals the minimum of the average variable cost (AVC).

The supply curve shifts to the right.

The supply curve shifts to the left.

The supply curve becomes flatter.

The supply curve becomes steeper.

Correct Answer: B

Solution:

The imposition of a unit tax increases the cost per unit, shifting the supply curve to the left.

Rs 5

Rs 10

Rs 15

Rs 20

Correct Answer: B

Solution:

Total revenue (TR) is calculated as market price (p) multiplied by quantity (q). Given TR = Rs 200 and q = 20, the market price p = TR/q = Rs 200/20 = Rs 10.

Increase production.

Decrease production.

Maintain current production level.

Exit the market immediately.

Correct Answer: B

Solution:

To maximize profit, a firm should produce where the market price equals the marginal cost. Since the MC is greater than the market price, the firm should decrease production.

Market price is less than the minimum of LRAC

Market price is equal to LRMC and greater than or equal to LRAC

Market price is greater than LRMC but less than LRAC

Market price is equal to LRAC

Correct Answer: B

Solution:

In the long run, a profit-maximising firm will produce a positive level of output if the market price is equal to LRMC and greater than or equal to LRAC.

The supply curve shifts to the right.

The supply curve shifts to the left.

The supply curve remains unchanged.

The supply curve becomes vertical.

Correct Answer: B

Solution:

An increase in input prices raises the cost of production, causing the supply curve to shift to the left.

The supply curve shifts to the left.

The supply curve shifts to the right.

The supply curve becomes vertical.

The supply curve remains unchanged.

Correct Answer: B

Solution:

Technological progress allows a firm to produce more output with the same level of inputs, reducing marginal costs and shifting the supply curve to the right.

Continue producing as it is making a profit.

Increase production to lower average costs.

Exit the market as it is incurring losses.

Reduce production to increase profits.

Correct Answer: C

Solution:

In the long run, if the market price is less than the LRAC, the firm is incurring losses and should exit the market.

75 units

100 units

125 units

150 units

Correct Answer: B

Solution:

The price elasticity of supply (PES) is calculated as the percentage change in quantity supplied divided by the percentage change in price. Given PES = 2, initial price = Rs 10, new price = Rs 15, and initial quantity = 50 units, the percentage change in price is (15-10)/10 = 0.5. Therefore, the percentage change in quantity is 2 * 0.5 = 1. The new quantity supplied is 50 * (1 + 1) = 100 units.

Market price is less than average cost.

Market price is equal to marginal cost.

Market price is greater than marginal cost.

Market price is less than marginal cost.

Correct Answer: B

Solution:

For a profit-maximising firm producing positive output, the market price must be equal to the marginal cost.

The supply curve shifts to the right

The supply curve shifts to the left

The supply curve becomes vertical

The supply curve does not change

Correct Answer: B

Solution:

The imposition of a unit tax increases the firm's costs, causing the supply curve to shift to the left.

The supply curve shifts to the right.

The supply curve shifts to the left.

The supply curve becomes vertical.

The supply curve remains unchanged.

Correct Answer: A

Solution:

Technological progress allows a firm to produce more output with the same input, reducing marginal costs and shifting the supply curve to the right.

The firm is making super-normal profits.

The firm is making normal profits.

The firm is incurring losses.

The firm is breaking even.

Correct Answer: B

Solution:

In the short run, a profit-maximizing firm produces where the market price equals the SMC and is greater than or equal to the AVC. This indicates that the firm is covering its variable costs and making normal profits.

Rs 10

Rs 20

Rs 30

Rs 40

Correct Answer: C

Solution:

Total revenue is calculated as the market price multiplied by the quantity produced, so Rs 10 × 3 = Rs 30.

Continue producing as it is

Increase production

Decrease production

Cease production

Correct Answer: D

Solution:

In the short run, a profit-maximizing firm will cease production if the market price is less than the minimum of AVC.

Continue producing to cover fixed costs.

Shut down production immediately.

Increase output to reduce average costs.

Decrease output to increase average revenue.

Correct Answer: B

Solution:

In the short run, if the market price is below the minimum AVC, the firm cannot cover its variable costs and should shut down to minimize losses.

The supply curve will shift to the left.

The supply curve will shift to the right.

The supply curve will remain unchanged.

The supply curve will become vertical.

Correct Answer: B

Solution:

Technological progress reduces the marginal cost, leading to a rightward shift of the supply curve since the firm can supply more at each price level.

It shifts the supply curve to the right.

It shifts the supply curve to the left.

It makes the supply curve steeper.

It has no effect on the supply curve.

Correct Answer: B

Solution:

The imposition of a unit tax increases the firm's long-run average cost and long-run marginal cost, shifting the supply curve to the left.

Firms can influence the market price.

Products are differentiated.

There are barriers to entry and exit.

There is perfect information.

Correct Answer: D

Solution:

A perfectly competitive market is characterized by perfect information, meaning all buyers and sellers are fully informed about the market.

Market price is greater than average variable cost.

Market price is less than average variable cost.

Market price is equal to total cost.

Market price is less than total cost.

Correct Answer: A

Solution:

In the short run, a firm will continue to produce as long as the market price is greater than or equal to the minimum of average variable cost (AVC).

Initial output is 10 units, final output is 25 units.

Initial output is 15 units, final output is 30 units.

Initial output is 5 units, final output is 20 units.

Initial output is 20 units, final output is 35 units.

Correct Answer: A

Solution:

Using the elasticity formula:

\frac{\Delta Q}{\Delta P} = 0.5

, solve for initial and final output levels.

Continue producing to cover fixed costs.

Shut down production.

Increase production to lower average costs.

Raise prices to increase revenue.

Correct Answer: B

Solution:

In the short run, if the market price is less than the minimum of AVC, the firm should shut down production.

Increase production to maximize profit.

Maintain current production levels.

Decrease production to minimize losses.

Shut down production immediately.

Correct Answer: A

Solution:

In the short run, a profit-maximizing firm should produce where the market price equals the SMC, provided the price is above AVC. Since the market price is greater than both SMC and AVC, the firm should increase production to maximize profit.

The supply curve shifts to the right.

The supply curve shifts to the left.

The supply curve becomes perfectly elastic.

The supply curve remains unchanged.

Correct Answer: B

Solution:

An increase in input prices raises the cost of production, causing the firm's supply curve to shift to the left.

When the price is less than the minimum of AVC.

When the price is greater than the minimum of AVC.

When the price equals the minimum of AVC.

When the price is equal to the average cost.

Correct Answer: A

Solution:

In the short run, a firm will cease production if the market price is less than the minimum of AVC.

Increase production

Decrease production

Maintain current production level

Shut down production

Correct Answer: A

Solution:

In a perfectly competitive market, a firm maximizes profit by producing where the market price equals the SMC. Since the market price (Rs 20) is greater than SMC (Rs 18), the firm should increase production until SMC equals the market price.

10 units

15 units

20 units

25 units

Correct Answer: A

Solution:

The price elasticity of supply (PES) is 0.5, which means a 1% increase in price leads to a 0.5% increase in quantity supplied. The price change is from Rs 5 to Rs 20, a 300% increase. Therefore, the quantity supplied increases by 0.5 * 300% = 150%. If the increase is 15 units, the initial quantity must have been 10 units (since 150% of 10 is 15).

AR is always greater than market price.

AR is always less than market price.

AR is equal to the market price.

AR is independent of market price.

Correct Answer: C

Solution:

For a price-taking firm in a perfectly competitive market, the average revenue is equal to the market price, as the firm can sell any quantity at the market price.

Shifts the supply curve to the right

Shifts the supply curve to the left

Does not affect the supply curve

Makes the supply curve vertical

Correct Answer: B

Solution:

The imposition of a unit tax increases the firm's cost per unit of output, which shifts the supply curve to the left as the firm now supplies fewer units at any given market price.

The firm is making super-normal profits.

The firm is making normal profits.

The firm is incurring losses.

The firm should shut down.

Correct Answer: B

Solution:

When the market price equals LRAC, the firm covers all its costs including normal profit, meaning it is making normal profits.

The supply curve shifts to the left

The supply curve shifts to the right

The supply curve becomes vertical

The supply curve remains unchanged

Correct Answer: B

Solution:

Technological progress reduces the marginal cost of production, which shifts the firm's supply curve to the right. This means the firm can supply more output at any given market price.

50 units

60 units

70 units

80 units

Correct Answer: B

Solution:

The percentage change in price is (12 - 8) / 8 = 0.5 or 50%. With a price elasticity of supply of 1.5, the percentage change in quantity supplied is 1.5 * 50% = 75%. Therefore, the new quantity supplied is 40 * (1 + 0.75) = 70 units.

Marginal revenue is always greater than market price.

Marginal revenue is always less than market price.

Marginal revenue is equal to market price.

Marginal revenue is unrelated to market price.

Correct Answer: C

Solution:

In a perfectly competitive market, the marginal revenue of a price-taking firm is equal to the market price.

The firm is maximizing profit.

The firm should increase output.

The firm should decrease output.

The firm is operating at a loss.

Correct Answer: C

Solution:

For profit maximization, a firm should produce where price equals marginal cost (P = MC). Since MC > P, the firm should decrease output to maximize profit.

Market price must be greater than or equal to the long-run average cost (LRAC).

Market price must be less than the long-run average cost (LRAC).

Market price must equal the average variable cost (AVC).

Market price must be below the marginal cost (MC).

Correct Answer: A

Solution:

In the long run, a firm will only produce if the market price is greater than or equal to the LRAC, ensuring at least normal profits.

It is upward sloping.

It is downward sloping.

It is perfectly elastic.

It is perfectly inelastic.

Correct Answer: C

Solution:

The demand curve that a firm faces in a perfectly competitive market is perfectly elastic.

The supply curve shifts to the right

The supply curve shifts to the left

The supply curve becomes horizontal

The supply curve remains unchanged

Correct Answer: B

Solution:

An increase in the price of a key input raises the firm's production costs, leading to an increase in marginal cost at every output level. This shifts the firm's supply curve to the left, indicating that the firm will supply less output at any given market price.

Continue production at the current level

Increase production

Decrease production

Shut down production

Correct Answer: D

Solution:

In the short run, if the market price is less than the minimum average variable cost (AVC), the firm should shut down production. This is because the firm cannot cover its variable costs, and continuing production would result in greater losses than shutting down.

The supply curve shifts to the left.

The supply curve shifts to the right.

The supply curve becomes horizontal.

The supply curve remains unchanged.

Correct Answer: A

Solution:

A unit tax increases the firm's costs, shifting the supply curve to the left as the firm supplies less at each price level.

The market supply curve shifts to the right.

The market supply curve shifts to the left.

The market supply curve becomes steeper.

The market supply curve remains unchanged.

Correct Answer: A

Solution:

An increase in the number of firms in the market increases the total quantity supplied at every price level, causing the market supply curve to shift to the right.

The supply curve shifts to the right.

The supply curve shifts to the left.

The supply curve becomes steeper.

The supply curve remains unchanged.

Correct Answer: B

Solution:

A unit tax increases the firm's costs, leading to a leftward shift in the supply curve as the firm now supplies fewer units at any given market price.

5 units

10 units

15 units

20 units

Correct Answer: A

Solution:

The price elasticity of supply is defined as the percentage change in quantity supplied divided by the percentage change in price. Here, the percentage change in price is (20-10)/10 = 100%. Therefore, the percentage change in quantity supplied is 0.5 * 100% = 50%. If the initial quantity supplied was 10 units, the increase in quantity supplied is 50% of 10 units, which is 5 units.

The market supply curve shifts to the right.

The market supply curve shifts to the left.

The market supply curve becomes steeper.

The market supply curve remains unchanged.

Correct Answer: A

Solution:

An increase in the number of firms increases the total quantity supplied at each price, shifting the market supply curve to the right.

The entire marginal cost curve.

The rising part of the marginal cost curve above the minimum average variable cost.

The average cost curve.

The average variable cost curve.

Correct Answer: B

Solution:

The short run supply curve of a firm is the rising part of the marginal cost curve from and above the minimum average variable cost.

Shifts the supply curve to the left

Shifts the supply curve to the right

Makes the supply curve steeper

Makes the supply curve flatter

Correct Answer: B

Solution:

Technological progress allows a firm to produce more output with the same input, shifting the supply curve to the right.

Market price equals the short-run marginal cost (SMC), and SMC is non-decreasing.

Market price is less than the average variable cost (AVC).

Market price equals the long-run marginal cost (LRMC).

Market price is greater than the average fixed cost (AFC).

Correct Answer: A

Solution:

In the short run, a profit-maximizing firm in a perfectly competitive market will produce a positive level of output only if the market price equals the short-run marginal cost (SMC) and the SMC is non-decreasing.

Average revenue is greater than market price.

Average revenue is less than market price.

Average revenue is equal to market price.

Average revenue is unrelated to market price.

Correct Answer: C

Solution:

For a price-taking firm, the average revenue is equal to the market price, as stated in the key concepts of perfect competition.

The supply curve shifts to the left.

The supply curve shifts to the right.

The supply curve becomes horizontal.

The supply curve remains unchanged.

Correct Answer: B

Solution:

Technological progress increases efficiency, reducing costs and shifting the supply curve to the right, allowing the firm to supply more at any given price.

Rs 5

Rs 10

Rs 50

Rs 100

Correct Answer: C

Solution:

Total revenue is calculated as the market price multiplied by the quantity sold, so Rs 10 x 5 = Rs 50.

True or False

Correct Answer: True

Solution:

Total revenue is calculated as the market price of the good times the quantity of the good sold by the firm.

Correct Answer: False

Solution:

A price-taking firm in a perfectly competitive market will not set its price lower than the market price because it can sell as many units as it wants at the market price.

Correct Answer: True

Solution:

In a perfectly competitive market, the marginal revenue for a price-taking firm is equal to the market price because each additional unit sold adds exactly the market price to total revenue.

Correct Answer: True

Solution:

In a perfectly competitive market, firms are price-takers, meaning they sell their goods at the market price. Therefore, average revenue, which is total revenue divided by quantity, is equal to the market price.

Correct Answer: False

Solution:

The imposition of a unit tax increases the cost of production, which shifts the supply curve of a firm to the left.

Correct Answer: True

Solution:

For a price-taking firm, average revenue is equal to the market price because the firm can sell any quantity of its product at the market price.

Correct Answer: True

Solution:

The short run supply curve of a firm is the rising part of the SMC curve from and above the minimum AVC, together with zero output for all prices less than the minimum AVC.

Correct Answer: False

Solution:

In the long run, a firm will not produce if the market price is below the long run average cost, as it would incur losses.

Correct Answer: True

Solution:

In a perfectly competitive market, firms are price-takers. Setting a price above the market price means buyers will purchase from other firms at the market price.

Correct Answer: False

Solution:

In the short run, a profit-maximising firm will not produce if the market price is below the minimum average variable cost, as this would result in losses greater than fixed costs.

Correct Answer: True

Solution:

In a perfectly competitive market, a firm is a price-taker, so its average revenue equals the market price.

Correct Answer: False

Solution:

In a perfectly competitive market, firms are price-takers and cannot influence the market price by changing their output level.

Correct Answer: False

Solution:

An increase in input prices raises the cost of production, which typically shifts the firm's supply curve to the left, as the firm will supply fewer units at any given market price.

Correct Answer: True

Solution:

The long run supply curve of a firm is the rising part of the LRMC curve from and above the minimum LRAC, together with zero output for all prices less than the minimum LRAC.

Correct Answer: True

Solution:

In a perfectly competitive market, the demand curve that a firm faces is perfectly elastic, meaning it can sell any quantity at the market price.

Correct Answer: True

Solution:

In the long run, a firm will only produce if the market price is at least equal to the minimum of LRAC to cover all costs, including normal profit.

Correct Answer: True

Solution:

In a perfectly competitive market, the total revenue (TR) of a firm is defined as the market price of the good (p) multiplied by the firm's output (q), i.e., TR = p × q.

Correct Answer: True

Solution:

In a perfectly competitive market, a profit-maximising firm produces where the market price equals the marginal cost.

Correct Answer: True

Solution:

In a perfectly competitive market, the demand curve is perfectly elastic, meaning it is a horizontal straight line at the market price.

Correct Answer: False

Solution:

The imposition of a unit tax increases the firm's costs, shifting the supply curve to the left.

Correct Answer: False

Solution:

Technological progress typically shifts the supply curve to the right because it allows the firm to produce more output at the same cost or the same output at a lower cost.

Correct Answer: True

Solution:

For a price-taking firm in a perfectly competitive market, marginal revenue is equal to the market price.

Correct Answer: True

Solution:

The price elasticity of supply is defined as the percentage change in quantity supplied divided by the percentage change in market price.

Correct Answer: False

Solution:

In the short run, a profit-maximising firm will not produce if the market price is less than the minimum of AVC, as it would incur losses greater than its fixed costs.

Correct Answer: False

Solution:

In the short run, a firm will not produce a positive level of output if the market price is less than the minimum of AVC, as it would incur losses greater than its fixed costs.

Correct Answer: False

Solution:

An increase in input prices typically shifts the supply curve to the left because it raises the firm's production costs, reducing the quantity supplied at any given price.

Correct Answer: True

Solution:

The long run supply curve of a firm is the rising part of the LRMC curve from and above the minimum LRAC, as it represents the conditions under which the firm covers all its costs, including normal profit.

Correct Answer: False

Solution:

In the long run, a firm will not produce a positive output if the market price is less than the minimum of its average cost, as it would incur losses.

Correct Answer: True

Solution:

The short run supply curve is indeed the rising part of the SMC curve from and above the minimum AVC, as the firm will not produce below this point.

Correct Answer: True

Solution:

In the short run, the firm continues to produce as long as the price remains greater than or equal to the minimum of AVC. This is known as the short run shut down point.

Correct Answer: False

Solution:

In a perfectly competitive market, firms are price-takers, meaning they cannot influence the market price. The market price is determined by the overall supply and demand in the market.

Correct Answer: False

Solution:

Technological progress typically shifts a firm's supply curve to the right because it allows the firm to produce more output with the same amount of inputs, thereby reducing costs.

Correct Answer: False

Solution:

A profit-maximising firm in a competitive market will not produce a positive level of output in the short run if the market price is less than the minimum of average variable cost, as it would incur losses.

Correct Answer: False

Solution:

In the short run, a profit-maximising firm will not produce if the market price is less than the minimum AVC, as it would incur losses.

Correct Answer: False

Solution:

In the long run, a firm will not produce a positive output if the market price is less than the minimum of LRAC, as it would incur losses.

Correct Answer: True

Solution:

In a perfectly competitive market, the demand curve faced by a firm is perfectly elastic, meaning the firm can sell any quantity at the market price.

Correct Answer: True

Solution:

The market supply curve is derived by adding the quantities supplied by all firms at each price level, resulting in a horizontal summation.

Correct Answer: False

Solution:

In the short run, a firm will not produce if the market price is less than the minimum of average variable cost, as it would incur losses greater than its fixed costs.

Correct Answer: True

Solution:

In the long run, a firm will only produce if the market price is greater than or equal to the LRAC, ensuring that it covers all costs and earns at least normal profit.

Correct Answer: True

Solution:

In a perfectly competitive market, the average revenue (AR) for a price-taking firm is equal to the market price because AR is calculated as total revenue divided by quantity, which is the same as the market price.

Correct Answer: True

Solution:

The long run supply curve of a firm is the rising part of the LRMC curve from and above the minimum LRAC, as this is where the firm can cover all its costs and earn normal profit.

Correct Answer: True

Solution:

The short run supply curve is the portion of the SMC curve that lies above the minimum AVC.

Correct Answer: False

Solution:

In a perfectly competitive market, a price-taking firm cannot influence the market price; it can sell any quantity of output at the market price.

Correct Answer: True

Solution:

For a price-taking firm, average revenue is defined as total revenue divided by quantity, which equals the market price.

Correct Answer: True

Solution:

In the long run, a profit-maximising firm will produce a positive output only if the market price is at least equal to the LRAC.

Correct Answer: True

Solution:

In a perfectly competitive market, a profit-maximising firm produces where marginal revenue equals marginal cost, ensuring no additional profit can be made by changing the output level.

Correct Answer: True

Solution:

In a perfectly competitive market, the demand curve is perfectly elastic because firms can sell any quantity at the market price.

Correct Answer: True

Solution:

In the short run, a firm will continue to produce as long as the market price is at least equal to the minimum AVC, which covers its variable costs.

Correct Answer: False

Solution:

In the long run, a firm will not produce if the market price is less than the minimum of average cost (AC), as it would incur a loss.

Correct Answer: True

Solution:

The long run supply curve of a firm is indeed the rising part of the long run marginal cost curve from and above the minimum long run average cost together with zero output for prices less than the minimum long run average cost.

The Theory of the Firm under Perfect Competition

AI Learning Assistant

Learning Objectives

Learning Objectives

Detailed Notes

The Theory of the Firm under Perfect Competition

4.1 Perfect Competition: Defining Features

4.2 Revenue

4.3 Profit Maximisation

4.4 Supply Curves

4.5 Determinants of a Firm's Supply Curve

4.6 Price Elasticity of Supply

4.7 The Shut Down Point

4.8 Normal Profit and Break-even Point

Exam Tips & Common Mistakes

Common Mistakes and Exam Tips

Common Pitfalls

Exam Tips

Practice & Assessment

Multiple Choice Questions

Q1.If a firm in a perfectly competitive market observes that its total revenue is Rs 300 when selling 30 units, what is the market price per unit?

Correct Answer: B

Q2.What happens to a firm's supply curve when there is technological progress?

Correct Answer: B

Q3.If a firm in a perfectly competitive market faces an increase in the price of an input, how does this affect the firm's supply curve?

Correct Answer: B

Q4.What is the price elasticity of supply if a firm's revenue increases from Rs 50 to Rs 150 when the market price increases from Rs 10 to Rs 15?

Correct Answer: C

Q5.A firm in a perfectly competitive market observes that its long-run marginal cost (LRMC) is Rs 25, and the market price is Rs 25. If the long-run average cost (LRAC) is Rs 30, what should the firm do in the long run?

Correct Answer: B

Q6.What is the shut down point for a firm in the short run?

Correct Answer: C

Q7.How does the imposition of a unit tax affect the supply curve of a firm?

Correct Answer: B

Q8.If a firm in a perfectly competitive market observes that its total revenue is Rs 200 when selling 20 units, what is the market price per unit?

Correct Answer: B

Q9.A firm in a perfectly competitive market observes that its marginal cost (MC) is Rs 30 and the market price is Rs 25. What should the firm do to maximize its profit?

Correct Answer: B

Q10.In the long run, under what condition will a profit-maximising firm produce a positive level of output?

Correct Answer: B

Q11.What happens to a firm's supply curve if the price of an input increases?

Correct Answer: B

Q12.What happens to a firm's supply curve if there is technological progress?

Correct Answer: B

Q13.Consider a firm in a perfectly competitive market where the market price is Rs 15. If the firm's long-run average cost (LRAC) at its current output level is Rs 20, what should the firm do in the long run?

Correct Answer: C

Q14.In a perfectly competitive market, a firm supplies 50 units at a market price of Rs 10. If the price elasticity of supply is 2 and the market price increases to Rs 15, what will be the new quantity supplied?

Correct Answer: B

Q15.If a profit-maximising firm in a competitive market is producing positive output, which condition must hold?

Correct Answer: B

Q16.What happens to a firm's supply curve when a unit tax is imposed?

Correct Answer: B

Q17.In a perfectly competitive market, what happens to a firm's supply curve when there is a technological advancement?

Correct Answer: A

Q18.In a perfectly competitive market, if a firm is producing at a level where the market price is equal to the short-run marginal cost (SMC) but greater than the average variable cost (AVC), what is the firm's profit status?

Correct Answer: B

Q19.If the market price of a good is Rs 10 and a firm produces 3 units, what is the total revenue?

Correct Answer: C

Q20.If a firm in a competitive market is producing at a level where the market price is less than the minimum of AVC, what should the firm do in the short run?

Correct Answer: D

Q21.If a firm in a perfectly competitive market is producing at a level where the market price is less than the minimum average variable cost (AVC) in the short run, what should the firm do?

Correct Answer: B

Q22.A firm in a competitive market is considering technological progress that reduces its marginal cost (MC) at every output level. How will this affect the firm's supply curve?

Correct Answer: B

Q23.How does the imposition of a unit tax affect the supply curve of a firm in the long run?

Correct Answer: B

Q24.Which of the following is a characteristic of a perfectly competitive market?

Correct Answer: D

Q25.In the short run, under what condition will a profit-maximising firm continue to produce?

Correct Answer: A

Q26.What is the price elasticity of supply if the market price of a good changes from Rs 5 to Rs 20, resulting in an increase in quantity supplied by 15 units, and the elasticity is given as 0.5?

Correct Answer: A

Q27.If a firm in a competitive market is producing at a level where the market price is less than the average variable cost, what should the firm do in the short run?

Correct Answer: B

Q28.A firm in a perfectly competitive market observes that its short-run marginal cost (SMC) is Rs 30 and the market price is Rs 35. If the average variable cost (AVC) is Rs 28, what should the firm do to maximize profit?

Correct Answer: A

Q29.What is the impact of an increase in input prices on a firm's supply curve?

Correct Answer: B

Q30.In the short run, at what price level will a profit-maximizing firm in a competitive market cease production?

Correct Answer: A