Microeconomics Exam 3 Sample – Step-by-Step Study Guidance

Q1. If a perfectly competitive firm’s price is less than its average total cost but greater than its average variable cost, what is the firm’s situation?

Background

Topic: Short-Run Decisions in Perfect Competition

This question tests your understanding of how a perfectly competitive firm decides whether to continue operating or shut down in the short run, based on its costs and the market price.

Key Terms and Formulas:

• Average Total Cost (ATC): The total cost divided by the quantity produced.

• Average Variable Cost (AVC): The variable cost divided by the quantity produced.

• Shutdown Rule: In the short run, a firm should continue to operate if price ($P$) is greater than or equal to AVC, even if it is less than ATC.

Step-by-Step Guidance

1. Compare the market price to the firm’s ATC and AVC.

2. If $P < ATC$ but $P > AVC$, the firm is not covering all its costs, but it is covering its variable costs and part of its fixed costs.

3. Recall that as long as the firm covers its variable costs, it should continue to operate in the short run to minimize losses.

4. Think about what it means for the firm’s profit or loss in this scenario.

Try solving on your own before revealing the answer!

Final Answer: B) is incurring a loss.

Since the price is less than ATC but greater than AVC, the firm is covering its variable costs but not all of its total costs, so it is operating at a loss (but should not shut down in the short run).

Q2. Refer to Figure 12-4. If the market price is $30, should the firm represented in the diagram continue to stay in business?

Background

Topic: Short-Run Production Decisions in Perfect Competition

This question asks you to interpret a cost diagram to determine whether a firm should continue operating or shut down at a given market price.

Key Terms and Formulas:

• Market Price ($P$): The price at which the firm sells its product.

• Average Variable Cost (AVC): The cost per unit of variable inputs.

• Shutdown Point: The minimum point on the AVC curve. If $P < AVC_{min}$, the firm should shut down.

Step-by-Step Guidance

1. Locate the market price ($30) on the vertical axis of the diagram.

2. Find where this price intersects the firm’s cost curves (ATC and AVC).

3. Determine whether $P$ is above, below, or equal to the AVC at the relevant output level.

4. Recall the shutdown rule: if $P 3C AVC$, the firm should shut down; if $P 3E AVC$, it should continue operating.

Try solving on your own before revealing the answer!

Final Answer: D) Yes, because it is covering part of its fixed cost.

At $P = 30$, the firm covers its variable costs (since $P > AVC$), so it should continue to operate in the short run, even if it is not making a profit.

Q3. Profit is the difference between:

Background

Topic: Profit Calculation

This question tests your understanding of how profit is calculated in microeconomics.

Key Terms and Formulas:

• Total Revenue (TR): The total amount received from selling a product ($TR = P d Q$).

• Total Cost (TC): The total of all costs incurred in production (includes both explicit and implicit costs).

• Profit ($ ext{Profit}$): $Profit = TR - TC$

Step-by-Step Guidance

1. Recall the definition of total revenue and total cost.

2. Subtract total cost from total revenue to find profit.

3. Consider whether the question is asking about explicit costs only or all costs (explicit + implicit).

Try solving on your own before revealing the answer!

Final Answer: D) total revenue and total cost.

Profit is the difference between total revenue and total cost (including both explicit and implicit costs).

Q4. A firm will break even when:

Background

Topic: Break-Even Point

This question tests your understanding of the break-even condition for a firm in microeconomics.

Key Terms and Formulas:

• Break-Even Point: The output level where total revenue equals total cost, so profit is zero.

• Average Total Cost (ATC): $ATC = \frac{TC}{Q}$

• Price (P): The market price per unit.

Step-by-Step Guidance

1. Recall that breaking even means profit is zero ($TR = TC$).

2. Set up the equation: $P 3D ATC$ at the break-even point.

3. Compare this to the other options to see which matches the break-even condition.

Try solving on your own before revealing the answer!

Final Answer: C) P = ATC.

A firm breaks even when the price equals average total cost, so total revenue equals total cost.

Q5. Refer to Figure 12-6. To maximize his profit, Jason should produce the rate of output indicated by point:

Background

Topic: Profit Maximization in Perfect Competition

This question asks you to use a cost and revenue diagram to determine the profit-maximizing output for a perfectly competitive firm.

Key Terms and Formulas:

• Marginal Cost (MC): The additional cost of producing one more unit.

• Marginal Revenue (MR): The additional revenue from selling one more unit. In perfect competition, $MR = P$.

• Profit Maximization Rule: Produce where $MC = MR$.

Step-by-Step Guidance

1. Identify the MR (or price) line on the diagram.

2. Find the point where the MC curve intersects the MR line.

3. Determine which labeled point (a, b, d, e) corresponds to this intersection.

Try solving on your own before revealing the answer!

Final Answer: D) d.

Jason should produce at the output where MC = MR, which is indicated by point d on the diagram.

Q6. Refer to Figure 12-6. If Jason maximizes his profit, he will produce the output rate indicated by point ________ and his average profit will equal ________.

Background

Topic: Calculating Profit per Unit

This question tests your ability to use a cost diagram to determine profit per unit at the profit-maximizing output.

Key Terms and Formulas:

• Average Profit per Unit: $P - ATC$ at the profit-maximizing output.

• Profit Maximization: Occurs where $MC = MR$.

Step-by-Step Guidance

1. Identify the profit-maximizing output (from the previous question).

2. At this output, find the price ($P$) and the average total cost ($ATC$).

3. Calculate average profit per unit as $P - ATC$ at this output.

Try solving on your own before revealing the answer!

Final Answer: A) d; $3 minus ATC at point d

At the profit-maximizing output (point d), average profit per unit is the difference between the market price ($3) and the ATC at point d.