Perfect Competition worksheet

Perfect Competition: answer key

1. 1. (B) In perfect competition, MR equals the market price because the firm is a price taker. So MR = MC becomes P = MC. The firm produces the quantity where its marginal cost curve crosses the horizontal price line. (C) is wrong because maximizing total revenue means selling as much as possible while ignoring costs. A firm could have enormous revenue and still hemorrhage money on every unit.

2. 2. (B) Shutdown happens when P < minimum AVC. At that point, the firm can't even cover variable costs, so producing makes the loss worse than simply closing and paying fixed costs. (A) is the trap answer on virtually every practice exam. A firm below ATC but above AVC should keep producing. It's losing money, but it loses *less* by staying open.

3. 3. (B) Free entry and exit do the work here. Profits attract new firms, supply rises, price falls, and the process continues until P = minimum ATC and economic profit is zero. Zero economic profit means the firm earns a normal return covering all opportunity costs. (A) can't persist because positive profit is a signal that draws entry, which eliminates that profit over time. (D) is nonsensical because zero total revenue would mean the firm sells nothing at all.

4. 4. (A) A rightward demand shift raises the equilibrium price. At the higher price, each firm produces more (moving up along its MC curve) and earns economic profit because P now exceeds ATC. In the long run, entry would erode these profits. (C) is wrong because while each firm *takes* the market price, the market price itself still changes when demand shifts. The firm takes whatever the new equilibrium price happens to be.

5. 5. (B) At any price above minimum AVC, the firm uses P = MC to pick its quantity. Below minimum AVC, the firm shuts down and quantity supplied is zero. The supply curve is therefore the MC segment at or above the shutdown point. (A) is wrong; marginal cost isn't negative below AVC. The shutdown is about revenue failing to cover variable costs, not about the sign of MC.

6. 6. (B) P = MC is allocative efficiency. The price consumers pay for the last unit equals what it cost to produce. No reshuffling of resources could improve total welfare. (A) describes productive efficiency, which is producing at the lowest ATC. Related concepts, but they're distinct, and confusing them on the AP exam costs points.

7. 7. (B) Economic profit signals that returns here beat the opportunity cost of capital. New firms enter, market supply increases, equilibrium price falls. Entry continues until P = minimum ATC and economic profit is zero. (A) is wrong because a perfectly competitive firm *cannot* raise its price. It's a price taker. Charging above the market price means zero sales.

8. 8. (B) Competitive firms are price takers, not price makers. No individual firm can set or influence the market price. Price-making power belongs to monopolists and other imperfectly competitive firms. The other three options (many participants, identical products, free entry/exit) are all genuine features of perfect competition.

9. 9. (B) The shutdown rule: produce if P >= AVC. Here P = $14 > AVC = $12, so the firm covers variable costs and puts $2 per unit toward fixed costs. Shutting down means eating the full $6 gap between ATC and AVC on every unit as a pure fixed-cost loss, which is worse. (A) is the classic trap. Price below ATC means losses, yes, but the shutdown threshold is AVC, not ATC. (C) is wrong because the firm can't control the market price. It produces where P = MC, not where P = ATC. (D) confuses short-run shutdown with long-run exit, which happens only after persistent losses, not as an immediate reaction.

10. 10. (C) Zero economic profit = all explicit costs (wages, rent, materials) covered AND all implicit costs (the owner's foregone salary, the return capital could earn elsewhere) covered. The firm is doing fine. It just has no reason to enter or leave the industry. (A) is wrong because zero economic profit is not failure; every cost including opportunity cost is met. (B) confuses economic and accounting profit. A firm earning zero economic profit typically still reports positive accounting profit on its income statement. (D) describes the shutdown point where TR = TVC, a completely different concept.

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