Price Theory and Applications 9th Edition Steven Landsburg Test Bank

Price Theory and Applications 9th Edition Steven

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Chapter 7—Competition

TRUE/FALSE

1. A perfectly competitive firm is one that can sell any quantity that it wants at any price it wants.

ANS: F PTS: 1

2. A competitive firm faces a downward-sloping demand for its product.

ANS: F PTS: 1

3. For a competitive firm, marginal revenue is constant and equal to the market price.

ANS: T PTS: 1

4. A firm earns a positive economic profit when the market price exceeds its marginal cost.

ANS: F PTS: 1

5. As long as profits remain positive, a firm will want to increase the quantity produced.

ANS: F PTS: 1

6. Only variable costs are relevant to a firm's decision to shut down.

ANS: T PTS: 1

7. When a firm has chosen to shutdown it has exited the industry.

ANS: F PTS: 1

8. A competitive firm will exit the industry in the long run if the price of its product falls below its
average cost.

ANS: T PTS: 1

9. A firm that has not shut down in the short run will not shut down in response to a decrease in the
marginal costs.

ANS: T PTS: 1

10. For prices greater than the minimum value of average variable cost, the firm's short-run supply
curve coincides with its short-run marginal cost curve.

ANS: T PTS: 1

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 Chapter 7 Competition

11. Given two supply curves passing through the same point, the flatter one has the higher elasticity.

ANS: T PTS: 1

12. Industry's supply curves tend to be less elastic than the supply curves of individual firms.

ANS: F PTS: 1

13. The elasticity of supply is positive because prices and quantities are always positive.

ANS: F PTS: 1

14. In a competitive equilibrium, the industry's output is produced at the lowest possible cost because
each firm has the goal of minimizing its cost.

ANS: F PTS: 1

15. Higher costs, whether fixed or variable, will cause a leftward shift in the industry's short-run
supply curve.

ANS: F PTS: 1

16. The number of firms in an industry is fixed in the short run.

ANS: T PTS: 1

17. A new licensing fee would cause an immediate upward shift in an industry's short-run supply
curve.

ANS: F PTS: 1

18. In a long-run competitive equilibrium, both more efficient and less efficient firms earn zero
economic profit.

ANS: F PTS: 1

19. When a competitive firm earns zero profit, the market price is equal to both the firm's average and
marginal costs.

ANS: T PTS: 1

20. In a competitive constant-cost industry, all firms have the same break-even price.

ANS: T PTS: 1

21. A government subsidy would allow all firms in a competitive constant-cost industry to earn a
positive profit in the long run.

ANS: F PTS: 1

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Chapter 7 Competition

22. Sunk costs cannot affect a firm's short-run supply, but they can affect its long-run decision to exit
the industry.

ANS: F PTS: 1

23. If the market price is currently above the shut-down price, the firm will be making positive profits.

ANS: F PTS: 1

24. A competitive firm will exit an industry in the long run if the market price falls below the firm's
break-even price.

ANS: T PTS: 1

25. For a competitive firm with a downward sloping marginal cost curve, the supply curve and the
marginal cost curve look exactly the same

ANS: F PTS: 1

26. There is no reason for a competitive firm to stay in business if it is making zero economic profit.

ANS: F PTS: 1

27. A decrease in firms’ variable costs will cause the output of the market to decrease.

ANS: F PTS: 1

28. A technological advance that reduces firms’ variable costs will lead to higher profits in the long
run of a perfectly competitive industry.

ANS: F PTS: 1

MULTIPLE CHOICE

1. Which of the following is a good example of a firm that is not likely to be perfectly competitive?
a. Farmer Joe's wheat.
b. Coyote Wile’s beef ranch.
c. Captain John's salmon farm.
d. Aviator Alan's nonstop airline service from Seattle to Nome.
ANS: D PTS: 1

2. The marginal revenue curve of a competitive firm is

a. U-shaped.
b. a ray from the origin.
c. a horizontal line at the market price.
d. downward sloping.
ANS: C PTS: 1

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 Chapter 7 Competition

3. The demand curve faced by a competitive firm is

a. horizontal.
b. downward sloping.
c. upward sloping.
d. nonexistent.
ANS: A PTS: 1

4. Any firm, competitive or not, desiring to maximize profits, will choose its quantity according to
the rule, produce that quantity at which
a. marginal revenue = price.
b. marginal revenue = marginal cost.
c. average variable cost is at its minimum.
d. marginal cost is at its minimum.
ANS: B PTS: 1

5. A competitive firm's supply curve is determined by

a. its marginal costs.
b. the market price.
c. the zero-profit condition.
d. its fixed inputs.
ANS: A PTS: 1

6. If a firm is producing a quantity along the upward sloping portion of its marginal cost curve at
which marginal cost exceeds price and is earning positive economic profits, it should
a. continue to produce this quantity.
b. decrease the quantity produced because doing so will increase profit.
c. increase the quantity produced because profits are still positive.
d. wait for the price to increase to its current marginal cost.
ANS: B PTS: 1

7. A firm will shut down in the short run if its revenues fail to cover its
a. fixed costs.
b. variable costs.
c. total costs.
d. sunk costs.
ANS: B PTS: 1

8. A competitive firm will shut down its operations in the short run when the market price falls below
its
a. marginal revenue.
b. marginal cost.
c. average cost.
d. average variable cost.
ANS: D PTS: 1

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Chapter 7 Competition

9. A competitive firm's shutdown price is equal to the minimum value of the firm's
a. marginal cost.
b. average cost.
c. average variable cost.
d. fixed and sunk costs.
ANS: C PTS: 1

10. Ultimately, short-run supply curves are upward sloping because of

a. the irrelevance of fixed costs to the firm's decision making.
b. the factor-price effect.
c. diminishing marginal returns to the variable inputs.
d. the equality of demand and marginal revenue for competitive firms.
ANS: C PTS: 1

11. When a manufacturer produces 25 tables, the marginal and average costs are both equal to $50 per
table. A 26th table raises the marginal cost to $54 per table and the average cost to $52 per table.
What is the firm's elasticity of supply when 25 table are produced?
a. 1/4.
b. 1/2.
c. 1.
d. 2.
ANS: B PTS: 1

12. In the short run

a. firms can enter the industry but no firm can exit.
b. firms can exit the industry but no firm can enter.
c. firms can enter and exit the industry.
d. no firm can enter or exit the industry.
ANS: D PTS: 1

13. Different firms in a competitive industry will have differing shutdown points when
a. they have different cost curves.
b. they are charging different prices.
c. they entered the industry at different times.
d. they all have identical cost curves.
ANS: A PTS: 1

14. A factor-price effect occurs when increases in the industry's output

a. attract new firms to the industry.
b. raise the cost of a variable input.
c. cause new subindustries to be developed.
d. result in lower prices for consumers.
ANS: B PTS: 1

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 Chapter 7 Competition

15. An industry's output is produced at the lowest possible cost when

a. firms' marginal costs are equal.
b. firms minimize their average costs.
c. all firms earn the same profit.
d. output is evenly divided among the industry's firms.
ANS: A PTS: 1

16. A competitive firm's long-run supply curve is

a. horizontal at the firm's break-even price.
b. steeper than its long-run marginal cost curve.
c. identical to its long-run average cost curve.
d. more elastic than its short-run supply curve.
ANS: D PTS: 1

17. A competitive firm will exit an industry in the long run when the market price falls below its
a. marginal revenue.
b. marginal cost.
c. average cost.
d. average variable cost.
ANS: C PTS: 1

18. When do new firms tend to enter a competitive industry?

a. When the large firms in the industry are earning zero profit.
b. When the smaller firms are leaving the industry.
c. When the new entrants can earn positive profits.
d. When there is an absence of fixed costs in the long run.
ANS: C PTS: 1

19. Suppose all firms in an industry are identical. In the long run, entry and exit guarantee that all
firms will have zero
a. marginal cost.
b. average cost.
c. economic profit.
d. accounting profit.
ANS: C PTS: 1

20. The competitive firm's long-run supply curve

a. is always perfectly horizontal.
b. includes only that part of the long-run marginal cost curve that lies above long-run average
cost.
c. includes only that part of the long-run marginal cost curve that is sloping upwards.
d. is identical to its long-run average cost curve.
ANS: B PTS: 1

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Chapter 7 Competition

21. In the long run, a firm will exit an industry if the market price is less than its
a. break-even price.
b. shutdown price.
c. marginal cost.
d. fixed cost.
ANS: A PTS: 1

22. Bonzo is in business for himself making and selling Easter baskets. His daily cost for wicker is
$100 and his daily revenue is $120. Bonzo quit his job at the Basket Weaving factory where he
earned $15 a day, to enter the Easter basket business. Given this information, we know that his
accounting profit
a. is $120 and his economic profit is $105.
b. and economic profit are both $20.
c. is $20 and his economic profit is $5.
d. and economic profit are both $5.
ANS: C PTS: 1

23. Farmer Jane grows wheat on land that is bought and paid for. She figures her profit per acre is $60
because she puts $30 of purchased inputs onto each acre, $10 worth of her time into working on
each acre, and the harvested wheat sells for $100. Farmer Jane
a. has correctly calculated her economic profit.
b. has forgotten to include the opportunity cost of the land in her calculation of profit.
c. should not have included the value of her time in calculating profits.
d. should not have included any costs in calculating her economic profit.
ANS: B PTS: 1

24. Bonzo's success in the Easter Basket business has attracted more characters into the Easter Basket
industry. If Easter Basket making is a constant cost industry, Bonzo
a. and the new entrants can all expect to be enjoying his current level of profits.
b. can expect his profits to be driven down to zero as new competitors push the price down.
c. can expect to have to shutdown his operation in the face of new competition.
d. will have to increase his price to make up for the loss of any sales to new competitors.
ANS: B PTS: 1

25. Which of the following could cause an industry to be an increasing-cost industry?

a. The development of subindustries in response to industry growth.
b. The factor-price effect.
c. Identical break-even prices across firms.
d. Substantial economies of scale in production.
ANS: B PTS: 1

26. An industry is likely to be an increasing-cost industry when

a. all firms are identical.
b. it represents a negligible fraction of the total demand for inputs.
c. industry expansion permits the development of supporting subindustries.
d. some firms are more efficient than others.
ANS: D PTS: 1

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 Chapter 7 Competition

27. When will an industry's long-run supply curve be horizontal at firms' break-even price?
a. When expansion of the industry allows new input markets to develop.
b. When some firms are more efficient than others.
c. When specialized skills play a significant role in production.
d. When firms are identical and there is no factor-price effect.
ANS: D PTS: 1

28. The expansion of capital that can occur in the long-run but not, by definition, in the short-run,
means that the long-run supply is
a. perfectly horizontal while the short-run supply curve is upward sloping.
b. sloping downwards while the short-run supply curve is upward sloping.
c. less elastic than the short-run supply curve.
d. more elastic than the short-run supply curve.
ANS: D PTS: 1

29. Suppose that the sub sandwich business is a competitive, constant-cost industry. An increase in
demand for sub sandwiches, will, in the long-run lead to
a. an increase in price and industry output, but no increase in the output of existing firms.
b. no increase in price, no increase in the output of existing firms but an increase in industry
output because of new firms.
c. no increase in price and an increase in industry output as each existing firm produces
more.
d. no changes in price, output of existing firms or the number of firms in the industry.
ANS: B PTS: 1

30. Assume dental care is provided by a competitive industry. A new government regulation requires
each dentist to take a costly new exam for certification. What happens to the price of dental care?
a. The price of dental care rises in the short run and rises further in the long run.
b. The regulation will cause higher prices in the short run, but it will have no long-run
impact.
c. There is no change in the short run, but dentists will exit and prices will rise in the long
run.
d. The exam is a sunk cost, so the price of dental care does not change in either the short run
or the long run.
ANS: C PTS: 1

31. The annual insurance premiums for Michael’s Machine Shop have permanently risen because of a
recent series of thefts by employees, but there is no change in the premiums paid by Michael's
competitors. If machine shops are a competitive constant-cost industry, then in the long run
a. Michael's profit will fall to zero.
b. Michael's Machine Shop will be driven out of business.
c. the higher fixed costs will have no effect on Michael's pricing and production decisions.
d. the demand for service from Michael’s Machine Shop will fall.
ANS: B PTS: 1

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Chapter 7 Competition

32. Entry into the information technology industry becomes more attractive the more firms there are
because of the increased availability of already trained workers. Given this trend, it appears that
information technology is
a. an increasing-cost industry.
b. a constant-cost industry.
c. a decreasing-cost industry.
d. a government subsidized industry.
ANS: C PTS: 1

33. Suppose notebooks are produced by a competitive constant-cost industry. Which of the following
must cause Nanna's Notebooks to exit the industry in the long run?
a. Nanna's is notified of a rent increase, but her competitors' rents are unchanged.
b. A fire destroys half of Nanna's inventory.
c. A photographer wins a $10,000 judgment from a lawsuit charging that Nanna's used his
photos on notebook covers without permission.
d. The price of cardboard used in notebook production rises.
ANS: A PTS: 1

34. Which of the following is not necessarily true in the long for a competitive industry?
a. Firms earn zero profits.
b. Firms set MC = MR.
c. A firm will not produce if the market price is less than their break-even price.
d. The long-run supply curve is more elastic than the short-run supply curve.
ANS: A PTS: 1

35. Which of the following is not true in the long-run?

a. There are no variable costs.
b. There are no fixed costs.
c. Total costs equal variable costs.
d. Identical firms will make zero profits.
ANS: A PTS: 1

36. In the short run, a competitive firm will

a. Will produce a quantity where AC = MR.
b. Will produce a quantity where AVC = MR.
c. Will produce a quantity where MC = MR.
d. Will shut down if price falls below the minimum of average costs.
ANS: C PTS: 1

37. Consider a perfectly competitive firm with MC = 10 + q. If market demand is Q = 100 - P and the
current industry output is 80 units, then the firm will produce
a. zero units.
b. 10 units.
c. 20 units.
d. the answer cannot be determined without knowing what the supply curve is.
ANS: B PTS: 1

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 Chapter 7 Competition

38. Which of the following will cause equilibrium output in a market to increase?
a. A decrease in firms’ variable costs.
b. An outward shift of the demand curve.
c. Entry of more firms into the market.
d. All of the above.
ANS: D PTS: 1

39. If all firms in a competitive industry experience an increase in marginal costs, then which of the
following is most likely to occur in the short run?
a. Firms will enter the market. c. Firms will shutdown.
b. Existing firms will expand production. d. Firms will exit the market.
ANS: C PTS: 1

40. By setting MR = MC, a competitive firm decides to sell 100 units when the market price is $20.
The average cost of producing the 100 units is $18 per unit. If the firm has fixed costs of $500,
then the firm should
a. shutdown c. exit the industry
b. expand production d. increase their price
ANS: A PTS: 1

ESSAY

1. When can we expect a factor-price effect to occur? How does a factor-price effect alter an
industry's short-run and long-run supply curves?

ANS:
A factor-price effect occurs when the industry in question represents a substantial fraction of the
demand for a variable input. When the industry's output expands, the resulting increase in demand
for the input causes its price to rise, which in turn increases the marginal costs of firms in the
industry. In the presence of a factor-price effect, the industry's short-run supply curve will be more
inelastic than the sum of individual firms' short-run supply curves would otherwise indicate. In the
long run, a factor-price effect causes the industry to be an increasing-cost industry, even if the
firms are identical. In this case, the industry's long-run supply curve will be upward sloping.

PTS: 1

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Chapter 7 Competition

2. Day care is provided by a competitive constant-cost industry at a price of $40 per child per day.
The government wants to increase the availability of day care and thus chooses to build and
operate 50 new day care centers across the nation.

(i) In the short run, what happens to the price of day care? Does the total amount of day care
provided increase in the short run? What happens to the profits of day care centers?
(ii) In the long run, what happens to the size of the day care industry? What happens to the
price of day care and the profits of day care centers? Does the total amount of day care
provided increase in the long run?

ANS:
(i) In the short run, the supply of day care increases and the price of day care falls. The
equilibrium quantity of day care provided rises. Day care centers earn negative profits
because the price has fallen below their break-even price of $40 per child per day.
(ii) In the long run, economic losses cause some firms to exit the day care industry. The price
of day care returns to $40 per child per day, and the profits of day care centers return to
zero. The total amount of day care provided falls back to its original level, so the
government-operated centers add nothing to the industry's output in the long run.

PTS: 1

3. Assume glassware is produced by firms in a competitive industry, one of which is Gregor's

Glassworks.

(i) Suppose a rent increase is imposed on Gregor's Glassworks but not on its competitors.
When would the rent increase cause Gregor to exit the industry? Explain.
(ii) Suppose an earthquake destroys most of Gregor's stock but does not affect his
competitors. When would the damages cause Gregor to exit the industry? Explain.

ANS:
(i) The rent increase is a new fixed cost which would raise Gregor's break-even price. The
higher break-even price will drive Gregor out of business if he is in a constant-cost
industry, because he (like every other glassware firm) was indifferent about remaining in
the industry prior to the rent increase. On the other hand, Gregor may or may not exit the
industry if it is an increasing-cost industry. If Gregor is particularly efficient at producing
glassware, his break-even price may still be low enough after the rent increase to permit
him to remain in the industry.
(ii) The earthquake damages are a sunk cost and will not cause Gregor to exit the industry.
The damages cannot be avoided no matter what Gregor chooses to do, so they have no
effect on his decision to exit the industry.

PTS: 1

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 Chapter 7 Competition

4. Consider the following:

(i) Silver is more abundant and easier to extract from some mines than from others. Is silver
mining more likely to be a constant-cost or an increasing-cost industry? Justify your
choice.
(ii) Production of flags requires nylon, sewing machines, and unskilled labor. Is flag
production more likely to be a constant-cost or an increasing-cost industry? Justify your
choice.
(iii) Farmers make up a significant proportion of the demand for arable land. Is farming more
likely to be a constant-cost or an increasing-cost industry? Justify your choice.

ANS:
(i) Some silver mines will be more efficient than others. As the industry expands, new
mines will have higher break-even prices than existing mines. Therefore, silver mining is
likely to be an increasing-cost industry.
(ii) Flag production does not require any specialized skills, so firms are likely to equally
efficient and have identical cost curves. Flag production does not represent a significant
fraction of the demand for nylon, sewing machines, or unskilled labor, so firms' costs
will not be affected by industry expansion and contraction. Therefore, flag production is
likely to be a constant-cost industry.
(iii) As the farming industry expands, the demand for arable land will rise. The higher cost of
arable land will increase farmers' break-even prices. Therefore, farming is likely to be an
increasing-cost industry.

PTS: 1

5. Consider a competitive constant-cost industry in which each firm's marginal and average costs are
given by the formulas MC = 4q and AC = 2q + 50/q , where q represents the quantity supplied by
the firm.

(i) Determine the quantity supplied by each firm in long-run equilibrium, and determine the
firms' break-even price.
(ii) Suppose the market demand for the good produced by this industry is given by the
formula P = 320 - 2Q, where P is the market price and Q is the market quantity. If the
industry is in a long-run competitive equilibrium, what will be the market price and
quantity, and how many firms will be in the industry?

ANS:
(i) Solve the equation MC = AC to show that, in a long-run equilibrium, each firm produces
5 units and the break-even price is $20 per unit.
(ii) In long-run equilibrium, the market price will equal firms' break-even price of $20 per
unit. Substitute P = 20 into the demand formula to show that the equilibrium market
quantity is 150 units. Since each firm produces 5 units, there are 30 firms in the industry.

PTS: 1

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Chapter 7 Competition

6. Suppose bicycles are produced by a competitive constant-cost industry, which is initially in a long-
run equilibrium. For each of the following situations, design a supply-demand diagram that shows
how market price and quantity will be affected in both the short run and the long run. In your
diagrams, show the short-run supply, long-run supply, and demand curves, along with any shifts in
these curves. Label the initial long-run equilibrium E0, the new short-run equilibrium E1, and the
new long-run equilibrium E2.

(i) New health regulations require each bicycle firm to purchase an air purification system
to reduce hazardous fumes in the workplace. Who pays for this increased cost in the
short run? Who pays in the long run?
(ii) The cost of titanium alloy rises, which adds $10 to the cost of manufacturing each bicycle
frame. Who pays for this increased cost in the short run? Who pays in the long run?
(iii) Bicycling declines in popularity as more and more people take up in-line skating. How
are the profits of bicycle manufacturers affected in the short run? How are their profits
affected in the long run?

ANS:
(i) The air purification system is a fixed cost that does not depend on the number of bicycles
produced. Thus there is no shift in short-run supply and no short-run change in the
equilibrium price and quantity of bicycles. The new fixed cost will, however, lower firms'
profitability and raise their break-even price, causing the long-run supply curve to shift up.
Some firms will exit the industry and the short-run supply curve will shift to the left, causing
the long-run price of bicycles to rise and the quantity to fall as zero profits are reestablished.
Therefore, bicycle firms bear the entire cost in the short run, while consumers bear the entire
cost in the long run. This situation is illustrated in the accompanying diagram.

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 Chapter 7 Competition

(ii) In this situation, marginal cost has increased by $10 per bicycle. Thus the short-run
supply curve shifts up by $10 per bicycle, so the equilibrium price rises and the
equilibrium quantity falls. However, the price does not rise by the full $10 per bicycle, so
the increased cost is split between consumers and firms in the short run. Firms' break-
even price has also risen by $10 per bicycle, so the new short-run price is less than firms'
new break-even price, which causes some firms to exit the industry in the long run. The
short-run supply curve will shift further to the left, causing a further increase in the price
and decrease in the quantity. The entire cost of $10 per bicycle is paid for by consumers
in the long run. This situation is illustrated in the accompanying diagram.

(iii) The demand for bicycles falls, causing the market price and quantity to fall. The new
price is below firms' break-even price, so bicycle firms have short-run losses. Some firms
will exit in the long run, which shifts the short-run supply curve to the left. The price of
bicycles rises back up to firms' break-even price, and the quantity of bicycles bought and
sold declines further. The profits of the firms remaining in the industry are restored to
zero. This situation is illustrated in the accompanying diagram.

PTS: 1

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Price Theory and Applications 9th Edition Steven Landsburg Test Bank

Chapter 7 Competition

7. A perfectly competitive market has demand Q = 100 - P and supply Q = P - 10. An individual firm
has MC = 10 + 2Q.
(a) What is the market equilibrium price and quantity?
(b) How much output should the individual firm produce?
(c) Although it is has been claimed that this market is perfectly competitive, do your
answers to parts (a) and (b) suggest differently?

ANS:
(a) Setting supply = demand gives the equilibrium price of 55 and the equilibrium quantity
of 45.
(b) The individual firm has marginal revenue equal to the market price of 55 and sets it
equal to marginal cost to maximize profits. Hence they produce 22.5
(c) Yes, the answers to parts (a) and (b) suggest that the market is not perfectly competitive
because the firm from part (b) produces such a large fraction of total market output and
hence the assumption of a large number of small firms is not satisfied.

PTS: 1

8. From this chapter we know that a profit maximizing competitive firm will set its price equal to the
market price. Briefly describe why a profit maximizing competitive firm will not set its price
above the market price. Also, describe why a profit maximizing competitive firm will not set its
price below the market price.

ANS:
If the competitive firm sets its price above the market price the quantity demanded of its product
will fall to zero and thus profits will fall. At the same time, there is no reason for a competitive
firm to lower its price below the market since it can sell as much as it wishes at the market price.
By lowering its price, the firm reduces its revenue and thus reduces its profits.

PTS: 1

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