The basic model of pure competition reviewed in this chapter

1. Explain how the long run differs from the short run in pure competition. LO1

2. Relate opportunity costs to why profits encourage entry into purely competitive industries and

how losses encourage exit from purely competitive industries. L02

3. How do the entry and exit of firms in a purely competitive industry affect resource flows and

long‐run profits and losses? LO3

4. Using diagrams for both the industry and a representative firm, illustrate competitive long‐run

equilibrium. Assuming constant costs, employ these diagrams to show how (a) an increase and

(b) a decrease in market demand will upset that long‐run equilibrium. Trace graphically and

describe verbally the adjustment processes by which long‐run equilibrium is restored. Now

rework your analysis for increasing‐ and decreasing‐cost industries and compare the three longrun

supply curves. LO4

5. In long‐run equilibrium, P = minimum ATC = MC. Of what significance for economic

efficiency is the equality of P and minimum ATC? The equality of P and MC? Distinguish

between productive efficiency and allocative efficiency in

6. Suppose that purely competitive firms producing cashews discover that P exceeds MC. Will

their combined output of cashews be too little, too much, or just right to achieve allocative

efficiency? In the long run, what will happen to the supply of cashews and the price of cashews?

Use a supply and demand diagram to show how that response will change the combined amount

of consumer surplus and producer surplus in the market for cashew

7. The basic model of pure competition reviewed in this chapter finds that in the long run all

firms in a purely competitive industry will earn normal profits. If all firms will only earn a normal

profit in the long run, why would any firms bother to develop new products or lower‐cost

production methods? Explain. LO6

8. “Ninety percent of new products fail within two years—so you shouldn’t be so eager to

innovate.” Do you agree? Explain why or why not. LO6

9. LAST WORD How does a generic drug differ from its brand‐name, previously patented

equivalent? Explain why the price of a brand‐name drug typically declines when an equivalent

generic drug becomes available? Explain how that drop in price affects allocative efficiency.

PROBLEMS

1. A firm in a purely competitive industry has a typical cost structure. The normal rate of profit in

the economy is 5 percent. This firm is earning $5.50 on every $50 invested by its founders. What

is its percentage rate of return? Is the firm earning an economic profit? If so, how large? Will this

industry see entry or exit? What will be the rate of return earned by firms in this industry once the

industry reaches long-run equilibrium? LO3

2. A firm in a purely competitive industry is currently producing 1000 units per day at a total cost

of $450. If the firm produced 800 units per day, its total cost would be $300, and if it produced

500 units per day, its total cost would be $275. What are the firm’s ATC per unit at these three

levels of production? If every firm in this industry has the same cost structure, is the industry in

long‐run competitive equilibrium? From what you know about these firms’ cost structures, what

is the highest possible price per unit that could exist as the market price in long‐run equilibrium?

If that price ends up being the market price and if the normal rate of profit is 10 percent, then how

big will each firm’s accounting profit per unit be? LO5

3. There are 300 purely competitive farms in the local dairy market. Of the 300 dairy farms, 298

have a cost structure that generates profits of $24 for every $300 invested. What is their

percentage rate of return? The other two dairies have a cost structure that generates profits of $22

for every $200 invested. What is their percentage rate of return? Assuming that the normal rate of

profit in the economy is 10 percent, will there be entry or exit? Will the change in the number of

firms affect the two that earn $22 for every $200 invested? What will be the rate of return earned

by most firms in the industry in long‐run equilibrium? If firms can copy each other’s technology,

what will be the rate of return eventually earned by all firms? LO5