Problem Set

1. Why can’t an individual firm raise its price by reducing output or lower its price to increase sales volume in a purely competitive market?

2. What are the main characteristics of a perfectly competitive market that cause buyers and sellers to be price takers? Explain.

3. Explain the importance of free entry and exit in the perfect competitive market. That is, if free entry and exit did not exist, what impact would this have on the allocation of resources and on the ability of firms to earn above-normal profits over time?

4. Explain why the demand curve facing a perfectly competitive firm is assumed to be perfectly elastic(i.e., horizontal at the going market price)

5. Explain why the demand curve facing a monopolist is less elastic than one facing a firm that operates in a monopolistically competitive market (all other factors held constant).

6. Why do economists consider zero economic profit to be “normal”?7. How “perfectly” competitive do you think are the following markets: 1) stock market, 2) bond

market, 3) foreign exchange market, 4) world sugar market, and 5) world oil market? Explain.8. Explain whether each of the following is a perfectly competitive market. For each market that is

not perfectly competitive, explain why it is not.a. Corn farmingb. Retail booksellingc. Automobile manufacturingd. New home construction

9. Suppose you decide to open a copy store. You rent store space (signing a one-year lease to do so), and you took out a loan at a local bank and use the money to purchase 10 copiers. Six months later, a large chain opens a copy store two blocks away from yours. As a result, the revenue you receive from your copy store, while sufficient to cover the wages of your employees and the costs of paper and utilities, doesn’t cover all your rent and the interest and repayment costs on the loan you took out to purchase the copiers. Should you continue operating your business?

10. Suppose an assistant professor of economics is earning a salary of $75,000 per year. One day he quits his job, sells $100,000 worth of bonds that had been earning 5 percent per year, and uses the funds to open a book store. At the end of the year, he shows an accounting profit of $90,000 on his income tax return. What is his economic profit?