Chapter 14
Firms in Competitive Markets
REVIEW QUESTIONS
Describe the difference between average revenue and marginal revenue. Why are both of these
revenue measures important to a profit maximizing firm?
ANSWER: Average revenue is total revenue divided by the amount of output. Marginal revenue is the
change in total revenue from the sale of each additional unit of output. Marginal revenue is used
to determine the profit maximizing level of production and average revenue is used to help
determine the level of profits.
Explain what it means if a firm in a competitive market is labeled as a price taker.
ANSWER: A price taker is a firm whose production decisions have no influence on market price.
List and describe the characteristics of a perfectly competitive market.
ANSWER: There are many buyers and sellers in the market. The goods offered by the various sellers
are largely the same. Firms can freely enter or exit the market.
Use a graph to demonstrate the circumstances that would prevail in a competitive market where firms
are earning economic profits. Can this scenario be maintained in the long run? Carefully explain
your answer.
ANSWER: In a competitive market where firms are earning economic profits, new firms will have an
incentive to enter the market. This entry will expand the number of firms, increase the quantity
of the good supplied, and drive down prices and profit.
Explain the role of opportunity costs in differentiating between economic profits and accounting
profits.
ANSWER: Accounting profits do not account for the opportunity cost of doing business. Economic
profits take into account the opportunity cost of production (or conducting business).
Firms in Competitive Markets
REVIEW QUESTIONS
Describe the difference between average revenue and marginal revenue. Why are both of these
revenue measures important to a profit maximizing firm?
ANSWER: Average revenue is total revenue divided by the amount of output. Marginal revenue is the
change in total revenue from the sale of each additional unit of output. Marginal revenue is used
to determine the profit maximizing level of production and average revenue is used to help
determine the level of profits.
Explain what it means if a firm in a competitive market is labeled as a price taker.
ANSWER: A price taker is a firm whose production decisions have no influence on market price.
List and describe the characteristics of a perfectly competitive market.
ANSWER: There are many buyers and sellers in the market. The goods offered by the various sellers
are largely the same. Firms can freely enter or exit the market.
Use a graph to demonstrate the circumstances that would prevail in a competitive market where firms
are earning economic profits. Can this scenario be maintained in the long run? Carefully explain
your answer.
ANSWER: In a competitive market where firms are earning economic profits, new firms will have an
incentive to enter the market. This entry will expand the number of firms, increase the quantity
of the good supplied, and drive down prices and profit.
Explain the role of opportunity costs in differentiating between economic profits and accounting
profits.
ANSWER: Accounting profits do not account for the opportunity cost of doing business. Economic
profits take into account the opportunity cost of production (or conducting business).
