AP Microeconomics

6.4 AP Free Response Assignment

The following is a free response question released by the College Board from a previous AP exam to be
used as practice for future exams. You can complete the assignment in this document, using the drawing
tools in Word (or any photo editing program) or print this document, and complete the activity by hand,
submitting a scan or photo of your work. When you are done, submit the assignment for grading by your
instructor. This question will be graded out of 15 points.

1. Assume that two firms are operating with identical cost schedules, but one firm is in a perfectly
competitive industry and the other is in a monopolistically competitive industry.

(a) Using two correctly labeled graphs, show the long-run equilibrium price and output levels for
each of these two firms.

(b) Compare the long-run equilibrium price and output levels for these two firms.

The long-run equilibrium price for the perfectly competitive firm will be lower than the long-run
equilibrium price for the monopolistically competitive firm, while the long-run equilibrium
quantity for the perfectly competitive firm will be larger than the long-run equilibrium quantity
for the monopolistically competitive firm.

(c) What level of economic profit will each firm earn in the long run? Why do these results
occur?
Both firms will earn zero economic profits in the long run. Because there are no barriers to entry
in the long-run (by definition), positive economic profits would increase the number of firms in
the industry, decreasing profits until they are zero, while negative economic profits would
decrease the number of firms in the industry, increasing profits until they are zero.

(d) For each of the two firms at the equilibrium quantity, indicate whether the firm’s demand
curve is perfectly elastic, inelastic, unit elastic, inelastic, or perfectly inelastic. How can you tell?
Demand is perfectly elastic for the perfectly competitive market because the demand curve is horizontal
– and the price is constant: i.e. a decrease in price will cause demand to go to infinity, while a increase in
price will cause demand to fall to zero. In contrast, the monopolistically competitive firm has elastic
demand. We know this because the marginal revenue is nonzero at the equilibrium quantity.