Chapter 7: costs of production
True or False?
Fixed costs remain the same regardless of output level. Explain your answer.
True. Fixed costs (like rent or insurance) do not change with output, they’re paid even if production is zero.
True or False?
A perfectly competitive firm can influence market price. Explain your answer.
False, With many small firms and identical products, no single firm affects the market price.
Long-run economic profit = __________.
Explain your answer.
Zero, Entry/exit of firms drives profit to normal (zero) in long-run equilibrium.
What are barriers to entry for a monopoly
patents and licenses, natural barriers such as economies of scale and control over resources, and strategic barriers like predatory pricing and brand loyalty
True or False?
MC pricing requires subsidy because P < ATC.
True
- Setting P = MC covers variable costs but not fixed costs.
If total cost rises from $100 to $160 when output increases by 10 units, MC = ?
a) $6 b) $10 c) $16 d) $60
a) $6
MC = change in TC ÷ change in Q = ($160 − $100) ÷ 10 = $6 per unit.
If price < AVC, the firm should:
a) Continue producing b) Expand c) Shut down d) Ignore the problem
-What happens when a firm shuts down?
C) shut down
they still have to pay their fixed costs because their sunk costs
A cable company keeps prices low to deter entrants. What market does this represent?
a) Natural monopoly b) Contestable c) Competitive d) Oligopoly
In a contestable market the threat of new firms entering pressures the existing firm to keep prices low, even if there aren't currently many competitors so that's why the cable company keeps prices low
Airlines charging business travelers more = ________.
a) Predatory b) Price discrimination c) Bundling d) Limit pricing
b) Price discrimination = charging different prices to consumers with different elasticities.
A government requires a natural monopoly to charge a price equal to its average total cost (ATC). What type of regulation is being used?
A) Marginal-cost pricing
B) Fair return pricing
C) Production efficiency
D) Output regulation
B) fair return pricing or also called profit regulation is when P=ATC
Describe how diminishing marginal product affects marginal cost.
As productivity falls, more input is needed for each extra unit, increasing the marginal cost curve. each additional unit of a variable input (like labor) produces less additional output, making it more expensive to produce each new unit of the good.
Why does entry continue until profits = 0? Explain the entire process.
New firms enter when profits exist; entry expands supply, lowering price until only normal profit remains.
new firms enter the market, the supply curve shifts right, profit gets squeezed til normal profit is reached, firms leave the market and the process repeats
How can innovation yield temporary profit?
It lowers cost or improves quality before others imitate.
Why does monopoly restrict output?
To raise price above MC; this yields profit but causes deadweight loss.
What real-world costs are created by regulation itself, and why do they matter for policy decisions?
Regulation imposes administrative, compliance, and efficiency costs. These use government resources, require firms to file reports or alter behavior, and can slow innovation. Policymakers must weigh these against potential benefits.
administrative costs are the expenses the government incurs to create, enforce, and manage policies or taxes. Compliance costs are the time and money individuals or businesses spend to follow those rules, such as filing taxes or keeping records. Efficiency costs (or deadweight loss) occur when taxes or regulations distort behavior, causing resources to be used less productively than they could be.
Bryn starts a small coffee business while in college.
Calculate Bryn’s:
- Accounting profit
- Economic profit
Accounting profit:
72,000 - ( 12,000 + 18,000 + 9,000 + 6,000)= 27,0000
Economic profit:
27,000-15,000= 12,000
How do per-unit taxes affect output? Explain your answer. Draw it out on a graph
They raise MC, shifting supply left → higher price, lower quantity.
Describe the difference between a shutdown decision and an exit decision, and give an example of each in a real-world context
Shutdown = short run, temporary halt (seasonal ski resort in summer). Exit = long run, permanent (a coal plant shutting down permanently due to unprofitability). In the long run, if the firm decides to exit the market (not just temporarily shut down), it does not have to pay fixed costs anymore, Remember that in the long run there are NO fixed costs
Why might some monopolies be justified despite higher prices and restricted output?
A. Because economies of scale allow one firm to produce at a lower cost than multiple smaller firms.
B. Because monopolies naturally encourage more entrepreneurial innovation than small startups.
C. Because monopolies always produce higher quality products than competitive firms.
D. Because government regulation ensures all monopolies operate efficiently and fairly.
A) Economies of scale allows the the firm to produce at a lower cost and because of that natural monopolies occur
Draw the graph for profit regulation monopoly. Include: D, MR, MC, and ATC. Mark Qa and Pa where MR = MC and Pb on the demand curve.
Picture of graph for profit regulation monopoly
A manufacturing firm produces 20 units of output at a total cost of $500. Its fixed costs are $100. When the firm increases production from 20 units to 25 units, its total cost rises to $650.
A) At 20 units, calculate the firm’s variable cost, average variable cost, and average total cost.
B) Calculate the marginal cost per additional unit when production increases from 20 to 25 units.
C) At 20 units, the market price is $22 per unit. Is the firm earning an economic profit or loss, and how much?
A) VC= TC-FC= 500-100= $400
AVC= $400/20= $20
ATC= 500/20= $25
B) (650-500)/ (25-20) = $30
C) profit= Rev x Costs
= 22(20)=$440
$440-500= -$60, the firm is experiencing an economic loss
A firm in a perfectly competitive market faces:
Price = $15
ATC at Q = 100 units is $10
MC intersects MR at Q = 100 units
Instructions:
Draw the firm’s cost curves (MC, ATC) and the horizontal MR = P line.
Indicate the profit area and highlight it on the graph.
Calculate the firm’s total profit or loss:
profit will be $500
A firm adopts a new efficient production process.
A) What effect does this have on the ATC curve?
B) What effect does this have on the MC curve?
C) How does this effect the firms profit?
A) ATC curve shifts down (costs are lower at every level of output)
B) MC curve also shifts down (it costs less to produce an additional unit)
C) ATC is now further below P, so profit increases
Contrast long-run outcomes in perfect competition vs. monopoly when current profits are high.
Competition: high profits attract entry -> supply shifts right -> price falls -> profits go to zero in the long run
Monopoly: entry barriers block entrants -> output/prices don’t adjust much -> positive profits persist as long as P>MC
Key thing is that barriers to entry allow economic profits to persist in monopolies where as low barriers to entry in perfect competition drive profits down in the long run
Draw the graph for the production-efficiency monopoly. Include: D, MR, MC, and ATC. Mark Qa and Pa where MR = MC and Pb on the demand curve.
an image of production efficiency monopoly