Tackle the Test: Free-Response Questions

1. Question

   Draw a correctly labeled graph showing a perfectly competitive firm in long-run equilibrium.

   Rubric for FRQ 1 (7 points)

   

   1 point: Axes are correctly labeled.

   1 point: Demand curve is horizontal and labeled with some combination of “P,” “MR,” or “D.”

   1 point: Marginal cost curve is labeled and slopes upward.

   1 point: Profit-maximizing quantity is labeled on horizontal axis where MC = MR.

   1 point: Average total cost curve is labeled and U-shaped.

   1 point: Average total cost is equal to price at the profit-maximizing output.

   1 point: Marginal cost curve crosses the average total cost curve at the lowest point on the average total cost curve.

2. Question

   Suppose that paper is produced in a perfectly competitive, increasing-cost industry.

   
   

   
   

   1. Draw correctly labeled side-by-side graphs for a representative firm and for the paper market in long-run equilibrium.

      
      
      
      

      1. Label the market equilibrium price “P_M1” and the equilibrium quantity “Q_M1.”

         
         
      
      

      2. Label the firm’s marginal cost “MC₁,” its average total cost “ATC₁,” its demand curve “D_F1,” and its profit-maximizing price and quantity “Q_F1” and “P_F1,” respectively.

         
         
      
      
      
      
   
   

   2. Now suppose that increased reliance on digital communications causes a decrease in the demand for paper. Show the following on the graphs you drew for part (a):

      
      
      
      

      1. The new short-run market equilibrium price and quantity, labeled “P_M2” and “Q_M2.”

         
         
      
      

      2. The new short-run profit-maximizing price and quantity for the representative firm, labeled “P_F2” and “Q_F2.”

         
         
      
      
      
      
   
   

   3. Now suppose the market and the representative firm have adjusted to a new long-run equilibrium.

      
      
      
      

      1. Label the new equilibrium market price and quantity “P_M3” and “Q_M3.”

         
         
      
      

      2. Explain how and why the representative firm’s new average total cost curve differs from ATC₁.

         
         
      
      

      3. Draw the long-run supply curve for the market and label it “LRS.” (8 points)

         
         
      
      
      
      
   
   

   Rubric for FRQ 2 (8 points)

   1 point: Correctly labeled graph of the market with an upward-sloping supply curve, a downwardsloping demand curve, and the equilibrium price and quantity, P_M1 and Q_M1

   1 point: The firm’s profit-maximizing quantity, Q_F1, is shown on the quantity axis below the intersection of M_C1 and D_F1, which is horizontal at P_F1.

   1 point: The firm’s average total cost curve, ATC₁, is tangent to D_F1 above Q_F1.

   1 point: The market demand curve shifts leftward and the new short-run equilibrium price and quantity are labeled P_M2 and Q_M2.

   1 point: The firm’s demand curve shifts downward and the profit-maximizing price and quantity for the firm are labeled P_F2 and Q_F2.

   1 point: The market supply curve shifts leftward and the new equilibrium price and quantity are labeled P_M3 and Q_M3.

   1 point: The firm’s average total cost curve shifted down below ATC₁ because, when the size of an increasing-cost industry decreases, the resulting decrease in the demand for inputs leads to a decrease in the cost of those inputs.

   1 point: The long-run supply curve slopes upward and goes through the points (Q_M3, P_M3) and (Q_M1, P_M1).