Sample Paper — Theory of the Firm under Perfect Competition
SECTION A — Multiple Choice Questions (10 × 1 = 10 marks)
| 1. | Under perfect competition the demand curve faced by an individual firm is: | a) Upward sloping b) Downward sloping c) Horizontal straight line d) Vertical line | [1] |
| 2. | A firm under perfect competition is a: | a) Price maker b) Price taker c) Price regulator d) Monopoly | [1] |
| 3. | In the short run, a firm will continue to produce as long as: | a) P < AVC b) P > ATC c) P ≥ AVC d) P < ATC | [1] |
| 4. | In long-run equilibrium under perfect competition: | a) P = MC < AC b) P = MC = minimum AC c) P > MC d) P < MC | [1] |
| 5. | The profit maximisation rule is: | a) MC = AR b) MR = MC c) AC = MR d) TR = TC | [1] |
| 6. | If P < AVC, the firm should: | a) Continue production b) Increase output c) Shut down d) Expand production | [1] |
| 7. | At the break-even point economic profit is: | a) Positive b) Negative c) Zero d) Undefined | [1] |
| 8. | The short-run supply curve of a competitive firm is: | a) Entire MC curve b) MC curve above min AVC c) MC curve below AVC d) Horizontal | [1] |
| 9. | Perfect competition attains which efficiencies? | a) Allocative only b) Productive only c) Both allocative & productive d) Neither | [1] |
| 10. | In long-run equilibrium firms earn: | a) Supernormal profit b) Normal profit c) Loss d) Abnormal profit | [1] |
Show Answers (Section A)
- c) Horizontal straight line
- b) Price taker
- c) P ≥ AVC
- b) P = MC = minimum AC
- b) MR = MC
- c) Shut down
- c) Zero
- b) MC curve above min AVC
- c) Both allocative & productive
- b) Normal profit
SECTION B — Short Answer Questions (5 × 3 = 15 marks)
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11. Define perfect competition and list four key features.[3]
Show Answer
Definition: Perfect competition is a market structure with many small firms selling identical products and taking the market price as given.
Features: Many buyers & sellers; homogeneous product; free entry & exit; perfect information; price-taking behaviour; mobility of factors. -
12. Explain TR, AR and MR for a competitive firm.[3]
Show Answer
TR (Total Revenue) = P × Q.
AR (Average Revenue) = TR / Q = P.
MR (Marginal Revenue) = ΔTR / ΔQ = P for each extra unit in perfect competition (horizontal MR curve). -
13. What is the shutdown point? Explain briefly.[3]
Show Answer
The shutdown point is the price equal to minimum Average Variable Cost (AVC). If market price falls below this point, the firm cannot cover variable costs and should cease production in the short run (produce Q = 0).
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14. Distinguish between normal profit and economic profit (brief).[3]
Show Answer
Normal profit: minimum return to keep resources in current use (zero economic profit).
Economic profit: TR − TC including implicit/opportunity costs; positive when TR > total (explicit+implicit) costs. -
15. State three determinants of supply.[3]
Show Answer
Technology; input prices (wages, raw materials); taxes & subsidies; number of firms; expectations about future prices.
SECTION C — Long Answer Questions (3 questions; any 2 to be answered) (2×7 = 14 marks)
CBSE-style: answer any two of the following three long questions. Each carries 7 marks.
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16. Explain the profit-maximisation condition MR = MC for a competitive firm. Draw a neat diagram showing (i) supernormal profit, (ii) normal profit, and (iii) loss. Label points (show workings / explanation).[7]
Show Answer
Explanation: Profit maximisation occurs where marginal revenue (MR) equals marginal cost (MC) and MC cuts MR from below. Under perfect competition MR = P (horizontal). At output Q* where P = MC, profit is maximised. Compare price with ATC at Q*:
- Supernormal profit: P > ATC at Q* → (P − ATC) × Q* positive rectangle.
- Normal profit: P = ATC at Q* → zero economic profit.
- Loss: ATC > P but P ≥ AVC → firm produces but incurs loss (smaller than TFC); if P < AVC → shut down.
Diagram (sketch to be drawn): Draw horizontal AR=MR=P line; U-shaped ATC and AVC; upward-sloping MC intersecting MR. Shade profit rectangle when P > ATC, etc.
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17. Differentiate between the short-run supply curve and long-run supply curve of a firm under perfect competition. Give reasons for differences.[7]
Show Answer
Short-run (SR): At least one factor fixed (e.g., capital). SR supply for competitive firm = portion of MC above min AVC. Firms cannot enter/exit; fixed plant restricts adjustments.
Long-run (LR): All factors variable. Firms can change plant size, enter or exit industry. LR supply relates to LRMC and LRAC; in constant-cost industry LR supply horizontal at min LRAC; in increasing-cost industry LR supply slopes up.
Reasons for differences: In LR firms can adjust scale and number of firms; fixed costs irrelevant; entry/exit drives profits to zero; cost structures (economies/diseconomies) affect LR supply slope.
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18. Discuss the effect of a per-unit tax and of a per-unit subsidy on a competitive firm’s supply, output and price. Use diagrams/logic.[7]
Show Answer
Per-unit tax (t): Increases marginal cost by t → MC shifts upward by t. Firm’s supply (MC above AVC) shifts left. For given demand, equilibrium price paid by buyers rises, quantity falls. Tax wedge separates price paid and price received; tax revenue = t × Q_tax. Deadweight loss arises from reduced trades.
Per-unit subsidy (s): Lowers MC by s → MC shifts down. Supply shifts right. Price paid by buyers falls, quantity increases. Government bears subsidy cost s × Q_subsidy; welfare effects include increased producer surplus but fiscal cost and potential deadweight loss depending on distortion.
Diagram (sketch): Show supply curves (pre and post-shift), mark new equilibrium prices and quantities, and tax/subsidy wedge.
SECTION D — Numerical / Application (Optional) (1 question) (1 mark extra credit)
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19. (Numerical) A competitive firm faces price P = 20. Its TC for Q = 0..5 are: 10, 15, 20, 30, 45, 65. Compute TR and profit for Q = 0..5 and identify profit-maximising output.[1 — Extra]
Show Answer
Q TC TR = 20×Q Profit = TR − TC 0 10 0 −10 1 15 20 5 2 20 40 20 ← highest 3 30 60 30 (check MC) 4 45 80 35 (profit increasing) 5 65 100 35 (profit same as Q=4)Profit is maximised at Q = 4 or Q = 5 (both give profit 35). Confirm MR = 20 approx equals MC at the chosen Q.