These are original Marlbridge practice questions, not past exam questions. The mark points are a suggested Marlbridge rubric to help you check your work; they are not an official scoring guideline. All firms, markets and data are fictional. Assume every market in this set is perfectly competitive and has no externalities. A four-function calculator is enough.
Question 1 (multiple choice · foundation)
Why does a single firm in a perfectly competitive market face a horizontal demand curve?
- (A) Market demand for the product is perfectly elastic.
- (B) The firm sells an identical product and is tiny relative to the market, so it can sell all it wants at the market price but nothing above it.
- (C) The government sets a fixed price for the product.
- (D) The firm has no fixed costs, so its costs do not change with output.
Answer and explanation
Answer: (B). A firm that raised its price would lose all its customers to identical rivals, and it is too small to affect the market price. So its demand curve is horizontal: P = MR = d.
- (A) confuses the firm with the market. Market demand slopes downward; only the demand facing one firm is horizontal.
- (C) describes a price control; here the market sets the price.
- (D) is about costs; the demand curve depends on buyers.
Question 2 (multiple choice · core)
Brookfield Mill sells sacks of flour at the market price of $8. It produces 300 sacks per day, where MC = MR. At that output its average total cost is $9 and its average variable cost is $6. Which statement is correct?
- (A) It earns an economic profit of $600 per day.
- (B) It makes an economic loss of $300 per day and should keep producing in the short run.
- (C) It makes an economic loss of $900 per day and should shut down.
- (D) It makes an economic loss of $2,700 per day.
Answer and explanation
Answer: (B). Profit = (P − ATC) × q = (8 − 9) × 300 = −$300. P = $8 is above AVC = $6, so producing loses less than shutting down.
- (A) uses AVC instead of ATC: (8 − 6) × 300 = $600 ignores fixed cost.
- (C) $900 is the fixed cost, (9 − 6) × 300: the loss if the mill shut down, which is worse than producing.
- (D) $2,700 is total cost (9 × 300), not profit. Total revenue of $2,400 must be subtracted.
Question 3 (multiple choice · core)
A perfectly competitive industry is in long-run equilibrium. Demand for its product then rises permanently. As the industry grows, firms must pay higher wages for the scarce skilled workers it uses. Compared with the original long-run equilibrium, what happens in the new long-run equilibrium?
- (A) The price is the same and each firm earns zero economic profit.
- (B) The price is higher and each firm earns positive economic profit.
- (C) The price is higher and each firm earns zero economic profit.
- (D) The price is lower and each firm earns zero economic profit.
Answer and explanation
Answer: (C). Expansion raises input prices, so every firm’s ATC shifts up (an increasing-cost industry). Entry continues until price equals the new, higher minimum ATC, where economic profit is again zero.
- (A) describes a constant-cost industry, where input prices do not change.
- (B) misses that, with no barriers, entry continues until economic profit is zero.
- (D) describes a decreasing-cost industry, where expansion makes inputs cheaper.
Question 4 (calculation · core)
Hollin Farm sells crates of eggs in a perfectly competitive market. Its fixed cost is $40 per day.
| q (crates per day) | 0 | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
|---|---|---|---|---|---|---|---|---|
| Total cost ($) | 40 | 62 | 78 | 90 | 104 | 124 | 152 | 190 |
(a) The market price is $30 per crate. Find Hollin’s profit-maximising output and its economic profit. (b) The price falls to $18. Find the new output and economic profit or loss. (c) Below what price should Hollin shut down in the short run? (d) All egg farms are identical, and the industry has constant costs. What will the long-run price be, and how many crates will Hollin produce?
Worked solution
First find MC (change in TC), AVC ((TC − 40) ÷ q) and ATC (TC ÷ q):
| q | 1 | 2 | 3 | 4 | 5 | 6 | 7 |
|---|---|---|---|---|---|---|---|
| MC ($) | 22 | 16 | 12 | 14 | 20 | 28 | 38 |
| AVC ($) | 22.00 | 19.00 | 16.67 | 16.00 | 16.80 | 18.67 | 21.43 |
| ATC ($) | 62.00 | 39.00 | 30.00 | 26.00 | 24.80 | 25.33 | 27.14 |
(a) P = MR = $30. The 6th crate has MC $28 (≤ $30: produce it); the 7th has MC $38 (> $30: do not). q = 6. TR = 30 × 6 = $180; TC = $152; profit = $28 per day.
(b) P = $18. The 4th crate has MC $14 (produce it); the 5th has MC $20 (do not). q = 4. TR = 18 × 4 = $72; TC = $104; profit = −$32, a loss of $32 per day (less than the $40 lost by shutting down).
(c) Minimum AVC is $16 (at q = 4). Below $16, Hollin cannot cover its variable costs, so it should shut down.
(d) In a constant-cost industry the long-run price is minimum ATC: $24.80. At that price the 5th crate (MC $20) is worth producing and the 6th (MC $28) is not, so Hollin produces 5 crates, and TR = 24.80 × 5 = $124 = TC: zero economic profit.
Suggested mark points (4): 1 for q = 6 and $28 profit; 1 for q = 4 and a $32 loss; 1 for $16 as minimum AVC; 1 for $24.80 and q = 5.
Common error: stopping at q = 5 in (a) because profit per crate is larger there ($5.20 against $4.67). Total profit is larger at q = 6 ($28 against $26).
Question 5 (graph · core)
The perfectly competitive market for boxes of dried figs in Teravia, a fictional country, is in long-run equilibrium at a price of $12 per box. A typical firm sells 40 boxes per day. The industry has constant costs.
(a) Draw correctly labelled side-by-side graphs for the market and a typical firm in long-run equilibrium. (b) Demand for dried figs falls. The market price drops to $9. The typical firm now produces 30 boxes per day, where its ATC is $12.50 and its AVC is $4.50. On your graphs, show the new market price and the firm’s new output, and shade the firm’s economic loss. Calculate the loss. (c) Will the typical firm keep producing in the short run? Explain. (d) Explain what happens in the long run to the number of firms, the market price and the typical firm’s output.
Model answer and suggested Marlbridge rubric
(a) Market: axes “Price ($ per box)” and “Quantity (boxes per day)”; D₁ and S₁ cross at $12. Firm: same price axis, output q; a horizontal P = MR = d line at $12 meets MC where MC crosses the U-shaped ATC at its minimum, at q = 40.
(b) D₂ lies left of D₁ and crosses S₁ at $9. The firm’s new P = MR line at $9 meets MC at q = 30, where ATC is $12.50. The loss is the rectangle between $12.50 and $9, from 0 to 30 boxes.
Loss = (P − ATC) × q = (9 − 12.50) × 30 = −$105: a loss of $105 per day.
(c) Yes. P = $9 is above AVC = $4.50. Fixed cost is (12.50 − 4.50) × 30 = $240, so shutting down would lose $240, while producing loses only $105.
(d) Losses cause some firms to exit. Supply shifts left until the price is back at minimum ATC, $12 (constant costs). Each remaining firm produces 40 boxes again at zero economic profit. There are fewer firms and a lower market quantity.
| Point | What earns it |
|---|---|
| 1 | Side-by-side graphs, correctly labelled, with the firm in long-run equilibrium: P = MR = MC = minimum ATC at $12 |
| 1 | Demand shifts left; new P = MR line at $9 with q = 30 where MC = MR |
| 1 | Loss rectangle shaded between ATC at q = 30 and P, and loss of $105 |
| 1 | Keeps producing because P > AVC (or loss < fixed cost) |
| 1 | Long run: exit, supply shifts left, price returns to $12, each firm back to 40 |
Do not award the third point if the rectangle is drawn using minimum ATC ($12) instead of ATC at the chosen output ($12.50).
Question 6 (constructed response · core)
The perfectly competitive market for plain school notebooks in a fictional country is in long-run equilibrium. The market price is $2 per notebook.
(a) What is the marginal cost of producing the last notebook? What is the marginal benefit of the last notebook to buyers? What type of efficiency does this show? (b) Explain why the market is also productively efficient in the long run. (c) A new machine lowers the costs of every notebook maker. The industry has constant costs. Explain how prices guide firms and buyers from the old long-run equilibrium to the new one. (d) Is the market productively efficient in the short run, before entry is complete? Explain.
Model answer and suggested Marlbridge rubric
(a) Each firm produces where MC = P, so MC of the last notebook = $2. The price measures what the last buyer is willing to pay, so marginal benefit = $2. MB = MC means allocative efficiency: the market makes exactly the quantity whose last unit is worth as much to buyers as it costs to produce.
(b) Entry and exit drive the price to minimum ATC, so each firm produces at the lowest possible cost per unit: productive efficiency.
(c) The old $2 price is now above each firm’s ATC, so firms earn economic profits: a signal that buyers value notebooks more than they now cost to make. New firms enter, supply shifts right and the price falls. The lower price tells buyers notebooks are cheaper to produce, so they buy more. Entry stops when the price equals the new, lower minimum ATC.
(d) No. Before entry is complete, the price is above the new minimum ATC. Each firm produces where P = MC, which is beyond its efficient scale, so its ATC is above its minimum. (Each firm still sets P = MC, so allocative efficiency holds.)
| Point | What earns it |
|---|---|
| 1 | MC = $2 and MB = $2, identified as allocative efficiency |
| 1 | Long-run P = minimum ATC linked to productive efficiency |
| 1 | Lower costs → profit → entry → supply right → price falls to new minimum ATC |
| 1 | Explains the role of price as a signal to both firms and buyers |
| 1 | Not productively efficient in the short run because P > minimum ATC and firms produce away from minimum ATC |
Question 7 (calculation and explanation · stretch)
The perfectly competitive market for standard cotton hand towels in a fictional country has identical firms. Each firm’s minimum ATC is $6, reached at 500 towels per week. Market demand is Q = 90,000 − 5,000P. The market is in long-run equilibrium, and the industry has constant costs.
(a) Find the long-run price, the market quantity and the number of firms. (b) Demand rises permanently to Q = 110,000 − 5,000P. Find the new long-run price, market quantity and number of firms. (c) Suppose instead that the industry has increasing costs, so that after the rise in demand, each firm’s minimum ATC becomes $7, still at 500 towels per week. Find the new long-run market quantity and number of firms. (d) Compare your answers to (b) and (c) and explain the difference.
Model answer and suggested Marlbridge rubric
(a) Long-run price = minimum ATC = $6. Q = 90,000 − 5,000 × 6 = 60,000 towels per week. Number of firms = 60,000 ÷ 500 = 120.
(b) Constant costs: price returns to $6. Q = 110,000 − 30,000 = 80,000 towels. Firms = 80,000 ÷ 500 = 160, so 40 firms enter.
(c) Price = new minimum ATC = $7. Q = 110,000 − 35,000 = 75,000 towels. Firms = 75,000 ÷ 500 = 150, so 30 firms enter.
(d) With increasing costs, expansion bids up input prices (for example, cotton or skilled weavers), so each firm’s costs rise. The higher long-run price ($7 against $6) means buyers buy fewer towels (75,000 against 80,000), so fewer firms are needed (150 against 160). Long-run supply slopes upward instead of being horizontal. Both cases end with zero economic profit.
| Point | What earns it |
|---|---|
| 1 | $6, 60,000 towels and 120 firms |
| 1 | $6, 80,000 towels and 160 firms |
| 1 | 75,000 towels and 150 firms |
| 1 | Higher price explained by rising input costs as the industry expands, with lower quantity and fewer firms than in (b) |
Accept “40 more firms” and “30 more firms” as equivalent to the totals if the working is shown.
How did you do?
- Q1 wrong: re-read “The price taker’s demand curve” in the study guide.
- Q2 or Q4 wrong: re-read “How a price taker chooses output” and Worked example 1. Choose q by MC = MR and use ATC at that q.
- Q5 graph marked down: compare your graphs with Figures 1 and 2. Check the shared price axis and the rectangle height.
- Q3, Q6 or Q7 incomplete: re-read “Long-run equilibrium and efficiency”, “Long-run supply” and Worked example 2.
Then tick off the topic checklist.