Suppose you own and operate your own business.

Furthermore, suppose that interest

rates rise and another firm offers you a job paying twice what you thought you were
worth in the labor market. What has happened to your accounting profit? What has
happened to your economic profit? Are you more or less likely to con inue to operate
your own firm?
Accounting profit is unchanged. Economic profit
is reduced because implicit costs have risenthe
opportunity cost of your invested money and of
your time both went up. You are less likely to
continue to operate your own firm because it is
less profitable.

If a firm is operating in the area of constant returns to scale, what will happen to
average total costs in the short run if the firm expands production? Why? What will
happen to average total costs in the long run? Why?
In the short run, the size of the production facility
is fixed so the firm will experience di inishing
m
returns and increasing average total costs when
adding additional workers. In the long run,
the firm will expand the size of the factory and
the number of workers together, and if the firm
experiences constant returns to scale, average
total costs will remain fixed at the minimum.
When a small firm expands the scale of its operation, why does it usually first ex
perience increasing returns to scale? When the same firm grows to be extremely large,
why might a further expansion of the scale of operation generate decreas ng returns
to scale?
As a small firm expands the scale of operation,
the higher production level allows for greater
specialization of the workers and long-run
average total costs fall. As an enormous firm
continues to expand, it will likely develop coor
dination problems and long-run average total
costs begin to increase.
Why does a monopolist produce less than the socially efficient quantity of output?
For a monopolist, P > MR because for a mo
nopolist to sell another unit, it must reduce the
price on the marginal unit and all of its previous
units. Therefore, while a monopolist equates MR

and MC, it charges a price that is greater than

MC, which causes consumers to buy less than the
efficient amount of the good.
Are the monopolists profits part of the social cost of monopoly? Explain.
No. The monopolists profits are a redistribu ion of consumer surplus to producer surplus. The
social cost of monopoly is the deadweight loss
associated with the reduced production of output.
You go to your campus bookstore and see a coffee mug emblazoned with your
universitys shield. It costs $5 and you value it at $8, so you buy it. On the way to
your car, you drop it and it breaks into pieces. Should you buy another one or should
you go home because the total expenditure of $10 now exceeds the $8 value that you
place on it? Why?
You should buy another mug because the mar
ginal benefit ($8) still exceeds the marginal cost
($5). The broken mug is a sunk cost and is not
recoverable. Therefore, it is irrelevant.
Why must the long-run equilibrium in a competitive market (with free entry and exit)
have all firms operating at their efficient scale?
In the long-run equilibrium, firms must be
making zero economic profits so that firms are not
entering or exiting the industry. Zero profits occur
when P = ATC and for the competitive firm P =
MC determines the production level. P = ATC =
MC only at the minimum of ATC
Why is the short-run market supply curve upward sloping while the standard longrun market supply curve is perfectly elastic?
In the short run, firms cannot exit or enter the
market so the market supply curve is the hori
zontal sum of the upward-sloping MC curves of
the existing firms. However, in the long run, if
the price is above or below minimum ATC, firms
will enter or exit the market causing the price to
always return to minimum ATC for each firm, but
the total quantity supplied in the market rises and
falls with the number of firms. Thus, the market
supply curve is horizontal.
Under what conditions would the long-run market supply curve be upward sloping?
If an input necessary for production is in limited supply or if firms have different costs.