AP Economics – Test Practice Questions – Micro – Unit 3 –
Short Answer Free Response Questions
2. A single airline provides service
from City A to City B.
a. Explain how the airline will
determine the number of
passengers it will carry and the
price it will charge.
b. Suppose fixed costs for this
airline increase. How will this
increase in fixed costs affect the
airlines price and output
decisions in the short run?
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Answers:
Part A – The airline is operating as a
monopoly; the monopolist determines
quantity by equating MR = MC and
price from the downward sloping
demand curve.
Part B – The increase in fixed costs
increases ATC but leaves the MC curve
in the same place. Thus, since
marginal cost and demand have not
changed, the profit-maximizing price
and output do not change.
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3. Assume that Star Inc. is a
monopoly. Explain each of the
following for this firm.
a. Why marginal revenue and
demand are not equal.
b. How the profit-maximizing level
of output and the price are
determined in the short-run.
c. Why economic profits continue
to exist in the long run.
Part A – The marginal revenue curve
lies below the demand curve because
downward-sloping demand curve, price
maker/price seeker or the firm is the
market; and the firm must decrease
price on all units in order to sell
additional units.
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Part B – Profit-maximizing output is
determined where MR=MC, and price is
read off the demand curve for this
output.
Part C – Economic profits can continue
to exist in the long run because of
barriers to entry.
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4. What is the long-run equilibrium
condition for a perfectly competitive
firm? Is the long-run equilibrium
condition of a perfect competitor
allocatively and/or technically
(productively) efficient? Why or why
not?
A perfectly competitive firm is in long-
run equilibrium where price equals
marginal cost and where price equals
average total cost. In addition, the
perfectly competitive firm operates at
the lowest point on its average total cost
curve. In the long run, the perfectly
competitive firm is allocatively efficient
(P=MC) and technically efficient
(minimum ATC).
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5. Why do oligopolists prefer to use
nonprice competition rather than
price competition?
Oligopolists are characterized by
mutual interdependence. If the
oligopolist raises its price, rivals will not
follow and will therefore gain market
share. If the oligopolist lowers its price,
rivals will have to lower their prices in
order to keep from losing market share.
Therefore, the oligopolist often prefers
nonprice competition as a safer way of
competition.
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6. What is the long-run equilibrium
position for a monopolistically
competitive firm? How does the long-
run equilibrium position of a
monopolistically competitive firm
compare with the long-run
equilibrium position of a perfectly
competitive firm?
A monopolistic competitor in long-run
equilibrium operates where price equals
average total cost, so it earns zero
economic profit in the long run. This
long-run equilibrium occurs because
one of the characteristics of
monopolistic competition is that firms
can easily enter or leave the industry
(free entry). If monopolistic
competitors are earning short-run
economic profits, more firms will enter
the industry. This increases industry
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supply, lowers price and eliminates
economic profit. On the other hand, if
monopolistically competitive firms are
experiencing short-run economic losses,
firms will leave the industry to seek
economic profits elsewhere or existing
firms will cut production. This
decreases industry supply, raises price
and restores normal profits in the long
run to the firms remaining in the
industry. The monopolistic competitor
faces a downward-sloping demand
curve because of product
differentiation. The perfect competitor
faces a horizontal demand curve
because there is no product
differentiation. Because marginal
revenue is lower than price and because
profits are maximized where marginal
revenue equals marginal cost, the
monopolistically competitive firm is not
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allocatively efficient. Because price and
marginal revenue are equal, a perfectly
competitive firm does operate where
P=MC and is allocatively efficient. The
monopolistically competitive firm also
does not operate at the bottom of its
average total cost curve so it also is not
productively or allocatively efficient.
The perfect competitor does operate at
the bottom of its average total cost
curve.
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