AP Microeconomics : Perfectly Competitive Output Markets

Study concepts, example questions & explanations for AP Microeconomics

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Example Questions

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Example Question #1 : Perfectly Competitive Output Markets

A food safety issue causes a temporary halt in the production of hot dogs at a significant number of firms. What is the expected effect on the equilibrium price and quantity for hot dog buns, assuming a perfectly competitive marketplace?

Possible Answers:

Price increases, Quantity decreases

Price decreases, Quantity increases

Price decreases, Quantity decreases

Price increases, Quantity increases

No change

Correct answer:

Price decreases, Quantity decreases

Explanation:

Hot dogs and hot dog buns are a model pair of complementary goods. Few people buy one without buying the other. You can graph the situation described using supply and demand curves for each market.

In the hot dog market, a significant decrease in supply will result in an inward shift of the supply curve which results in a higher price and fewer hot dogs being bought and sold.

The resulting effect in the market for hot dog buns, with fewer hot dogs being sold, is an inward shift in the demand curve, which results in a decrease in both the market price and quantity sold of hot dog buns.

Example Question #1 : Competition

If there is a bumper crop in cotton the same year that it becomes very fashionable and consumers begin to demand it over other fabrics, what is the likely effect on the market price and quantity traded?

Possible Answers:

Price decreases, Quantity increases

Price increases, Quantity increases

Price increases, no change in Quantity

No change in Price, Quantity increases

Price indeterminate, Quantity increases

Correct answer:

Price indeterminate, Quantity increases

Explanation:

Graph supply and demand curves to represent the market for cotton. The changes described would result in an outward shift of both the supply and demand curves. The new equilibrium would clearly have an increase in the quantity traded, but the equilibrium price would depend on the slope of the curves. Therefore, without more information, the effect on the market price is indeterminate.

Example Question #3 : Perfectly Competitive Output Markets

Sugar can be refined from either sugar cane or sugar beets. Which of the following would result in an increase in the market price of sugar cane, assuming perfect competition?

Possible Answers:

A bumper crop of sugar cane

A sugar beet crop failure

A bumper crop of sugar beet

Consumers start eating less refined sugar

Correct answer:

A sugar beet crop failure

Explanation:

A sugar beet crop failure would result in an inward shift of the supply curve in the market for sugar beets, resulting in a higher equilibrium price.

Since sugar beets and sugar cane are substitutes, this would result in greater demand for sugar cane, which would result in a higher price for sugar cane as well.

Example Question #1 : Perfectly Competitive Output Markets

Sugar can be refined from either sugar cane or sugar beets. If there is a larger-than-expected harvest in BOTH sugar cane and sugar beets, what is the effect on the equilibrium price and quantity in the market for sugar cane?

Possible Answers:

Price indeterminate, Quantity increases

Price increases, Quantity increases

Price indeterminate, Quantity decreases

Price decreases, Quantity indeterminate

Neither Price nor Quantity can be determined from the information given.

Correct answer:

Price decreases, Quantity indeterminate

Explanation:

First, an increase in the supply of sugar beet results in a lower market price, and therefore lower demand for sugar cane, since they are substitutes. This translates into a lower market price and lower quantity traded for sugar cane.

Second, the increased supply of sugar cane would result in a lower market price and higher quantity traded in sugar cane. Therefore, the market price would definitely decrease, but the direction of the change in quantity cannot be determined.

Example Question #2 : Perfectly Competitive Output Markets

Compared to a perfectly competitive market, a monopolist produces...

Possible Answers:

less of a good and charges a lower price.

less of a good and charges a higher price.

more of a good and charges a lower price.

Unable to determine from the information given.

more of a good and charges a higher price.

Correct answer:

less of a good and charges a higher price.

Explanation:

As seen in the graph below, the monopolist faces a downward sloping marginal revenue curve that is steeper than the demand curve. The monopolist produces where MC = MR which results in a higher price and lower output compared to where the marginal cost curve meets the demand curve, which is where equilibrium would be in a perfectly competitive market.

Monopolist

 

Example Question #11 : Perfectly Competitive Markets

If a monopolist's marginal cost curve shifts down, what is the expected effect on price and quantity of the monopolist's output?

Possible Answers:

Price decreases, Output increases

Price decreases, Output decreases

Price decreases, Quantity indeterminate

Price indeterminate, Quantity increases

Cannot determine either Price or Quantity.

Correct answer:

Price decreases, Output increases

Explanation:

 

Although the monopolist will not end up producing at the socially optimal level, the effect of the change described is very similar to a shift in the supply curve in a perfectly competitive market.

Starting with the graph below as a baseline, you can see that if the marginal cost curve shifts down, the monopolist will produce at a point further along the marginal revenue curve, which would correspond to a greater output at a lower market price.

Monopolist

Example Question #2 : Perfectly Competitive Output Markets

A natural monopoly arises when which of the following characteristics of a perfectly competitive market are not met?

Possible Answers:

Perfect information

Firms sell where marginal revenue equals marginal cost

Well-defined property rights

Non-increasing returns to scale

Correct answer:

Non-increasing returns to scale

Explanation:

A natural monopoly is defined by an industry where production is most efficient (i.e. lowest long-run average cost) when it is concentrated in a single firm. This implies increasing returns to scale, which is not characteristic of perfect competition. In other words, the natural monopolist will have a significant cost advantage over smaller competitors that try to enter the market.

Example Question #4 : Perfectly Competitive Output Markets

A natural monopoly differs from a traditional monopoly in what way?

Possible Answers:

Maximizes profits

Lower average costs than same market with many firms

Can set price by determining quantity of good to be sold

High barriers to entry

Positive economic profit in the long-run

Correct answer:

Lower average costs than same market with many firms

Explanation:

A natural monopoly is very similar to and experiences the same inefficiencies as a traditional monopoly. The difference is that these inefficiencies cannot be corrected by increasing competition, as a single seller can produce more efficiently than many sellers in a market that is a natural monopoly.

Example Question #5 : Perfectly Competitive Output Markets

Assume that each of the following producers operates as a monopolist. Which one is most likely NOT a natural monopoly?

Possible Answers:

A regional provider of electricity

A railway network

A producer of a patented drug

A telecommunications provider

Correct answer:

A producer of a patented drug

Explanation:

The electric company, railway, and telecoms operator are all examples of industries with very high fixed costs where the lowest average cost could only be achieved at a high level output, which discourages competition and is characteristic of natural monopoly.

The drug-maker operates as a monopoly due to the legal barrier (patent) that prevents entry into the market (for that specific drug). Therefore, it is NOT a natural monopoly.

Example Question #4 : Perfectly Competitive Output Markets

Assuming the markets for pencils and erasers are perfectly competitive, what is the expected effect on the market for pencils if there is a sudden shortage in the rubber needed to produce erasers?

Possible Answers:

Cannot determine from information given.

Price increases, Quantity increases

Price decreases, Quantity decreases

Price decreases, Quantity increases

Price increases, Quantity decreases

Correct answer:

Price decreases, Quantity decreases

Explanation:

As pencils and erasers are used together they can be considered complementary goods. You can use a supply and demand graph for each market to track the following steps:

  • The shortage in rubber shifts the supply curve in the eraser market inward
  • As a result, the price of erasers increases
  • Since pencils and erasers go together, a higher price for erasers means people demand fewer pencils at any given price.
  • This results in an inward shift of the demand curve in the pencil market.
  • As a result, both the price and quantity of pencils being sold goes down.
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